As the balance due on a credit card grows higher, the cardholder may lose hope of paying their debt off. They may end up trapped in the cycle where they pay the monthly minimum payments due. All they end up covering are fees and interest. The principal balance either continues growing or remains the same. When there is very little wiggle room in an individual’s budget, reducing what they owe on credit cards may seem nearly impossible.
Debt settlement can often seem like the perfect solution. An outside company helps the cardholder negotiate with the company and the debtholder may end up paying a lower amount to settle their debt. That may seem like an excellent solution for people plagued by high credit card balances.
Unfortunately, credit card settlement may cause more problems than it solves. What are some of the risks of credit card settlements?
1. Surprise fees
Much of the time, companies offering credit card settlement services are actually lenders themselves. They provide their clients with a loan that they use to pay off their credit card balances.
Those loans may have a variety of fees and costs attached that can create future financial challenges for the borrower. While the borrower may owe less initially, the full amount due can quickly increase because of the fees the company assesses and the interest that accumulates.
2. Credit blemishes from settlement
Debt settlement is not the same thing as paying an account in full. Credit card companies frequently report the account as settled or partially paid. That can be a major blemish on an individual’s credit report that shows up for seven years.
Instead of resolving their credit card debt and keeping their accounts in good standing, the borrower may end up accumulating multiple significant credit blemishes that affect their eligibility for future lines of credit.
3. A sudden loss of credit
Credit card settlement typically results in the lender closing that line of credit. This may leave the cardholder without the financial flexibility they need to cover unexpected costs or recurring monthly expenses.
Obtaining a new line of credit can be difficult, as the negative reporting from a settled credit card and the balance owed on the new line of credit can combine to drag down an individual’s credit score. Additionally, closing multiple lines of credit at the same time can significantly reduce the length of an individual’s credit history and the number of active accounts, both of which can have major implications for their credit score.
While bankruptcy also results in the closure of credit lines and a decline in credit score, it may be a better solution. The effects of bankruptcy on creditworthiness often decrease significantly as people rebuild their finances after discharging their debts.
Fully eliminating credit card debt via personal bankruptcy may be a better solution than paying for debt settlement services. Cardholders worried about meeting their financial obligations may want to consider bankruptcy in addition to other potential debt solutions.