Debt Settlement Los Angeles CA

Scott,
My ex-husband has a friend who works with delinquent accounts at a credit card company. She told him that if he let his account go into delinquency that in about six months he'd be able to "settle" it for 40 percent of what he owed. 

I believe that part of it however, she also told him that it would NOT reflect badly on his credit report. That it would merely be noted as "settled" and that no creditor would see that unfavorably. I can't believe this is true and I am afraid my ex is going to very sadly surprised when he goes to by a house in a year. So before he goes ahead with this crazy scheme could you please confirm that what this person told him is true?
Rebecca

Rebecca,

Your intuition is correct.

It is true that credit card banks will not negotiate settlements until the debtor is delinquent for a minimum amount of time. It makes sense from their perspective because, why would they settle an account if the debtor were still making payments?

There is something else that your ex needs to know about settled account. The difference between the amount settle and the original balance will be reported to the IRS on a 1099 as income and taxes are due! This probably will not amount to much but it is another cost in settling an account.

Settled account will be reported as such. And you are correct to believe that this will be looked on negatively by other lenders. You don't have to be in the banking industry to come to that conclusion. Image the mortgage bank considering your ex's application. "Gee, looks like you 'settled' an account. Hmmm, let me see...you borrowed money from another bank and only repaid 40 percent. Wow! You're a good risk! Here's that $200,000 you need for the house." I think not.

If you do settle an account with a creditor you want to ask to make sure that one condition of the settlement is that the account is reported as "account paid satisfactor...

Scott,

We are drowning in debt--over $80,000 in credit card debt, some at over 30 percent! We are taking a second mortgage out on our house to pay it off. Should we ask the credit card companies to lower our payoff amount for paying off the balance in cash? Will this adversely affect our credit rating? Even a 10 percent reduction would pay for a car for my son. Your advice is appreciated!

Viola

Wow! That is a large amount of debt at a high rate! Even if you can afford to repay the principal, the interest rates are ridiculously high. At 30 percent, if you spent $2,100 per month paying down that $80,000, it will still take more than 10 years to repay and cost a total of $259,000 to pay off

Your plan to take a second mortgage on your home to save money is a good one. Of course, there are potential risks and rewards. The risks include the reality that you’re taking unsecured debt (the credit cards) and repaying it by using your home as collateral. This is okay as long as you’re not in any immediate financial trouble, like a job-loss situation.

The reward is that you will, or should, receive a much lower interest rate on the second mortgage, and you will be able to deduct the interest charges from your income for tax purposes. You can calculate your comparable credit card rate (the rate a credit card would need to be in order to match the second mortgage with taxes taken into account) by simply subtracting your tax rate from one and multiplying this by the second mortgage rate. For example, if you’re in the 15 percent tax bracket and your second mortgage rate is 7 percent, then your credit card rate would have to be 5.95 percent ([1-0.15] x 7) to match the 7 percent second mortgage with all its tax benefits.

Of course, getting the banks to reduce your outstanding balance would be nice. Then you wouldn’t have to refinance that entire $80,000 with the second mortgage. It’s probably true that much of that balance is from that rip-off 30 percent interest rate anyway! But, you do ask an important question, specifically, “Will this adversely affect our credit rating?”

Yes, it could! That’s because the credit card bank will report it as a settled account. And even further, you will receive a 1099, which will require you to pay taxes on the amount you save.

So what do you do?

Well, I would attempt to settle the account for less and make it part of the negotiation that the account is reported “paid as...