Credit card issuers are increasingly offering settlement deals to delinquent borrowers, in what may be an unprecedented attempt to salvage a fraction of the account balances they are owed.
Carol Kaplan, a spokeswoman for the American Bankers Association, calls lenders’ efforts to bargain “a fairly recent development.” With cash-strapped consumers facing high unemployment, record home foreclosures and shrinking personal wealth, Kaplan says banks are trying to curb widespread default on credit card debt.
‘What banks are doing is very prudent. They can either not get paid at all, or get paid something.’
“We’re seeing the nearly highest delinquency rates on record, and we do expect it to get higher,” she says. “What banks are doing is very prudent. They can either not get paid at all, or get paid something. I don’t know that we’ve ever seen such a proactive approach at stemming losses.”
The increase in delinquencies over the past year has been dramatic. While only 1.32 percent of bankcard holders were at least 90 days late on a payment in the first quarter of this year, that marked a steep 11 percent climb from a year earlier, according to TransUnion, a credit-reporting agency. Average card debt also increased, to $5,776 in the first quarter of this year from $5,548 over the same period last year.
And it looks like the squeeze will continue for some time. TransUnion predicts that credit card default rates won’t peak until early 2010. At that time, unemployment is expected to fall and the drop in disposable income should level off, so debt may become more manageable, the agency says.
Meanwhile, credit card issuers have written off billions of dollars in bad debt in the past year, according to the Nilson Report, the credit industry journal. The report says that from October 2007 to October 2008, JPMorgan Chase wrote off 5 percent of more than $183 billion in delinquent debt; Bank of America, 6 percent of $166 billion; and Citigroup, 8 percent of $107 billion.
No easy street
Banks are reluctant to provide details about settlement offers.
“Issuers are becoming much more accommodating, even though they don’t wish to admit it publicly,” says Adam Levin, cofounder and chairman of Credit.com, a consumer and education website. “Their chance to get anything is enhanced by moving quickly as people lose their jobs.
“But this shouldn’t be viewed as easy street,” he says. “There are ramifications to these settlements. You’ll take a hit on your credit score—it’s the highest negative you can get on your report.”
You also have to pay taxes on the amount of debt that is forgiven. For example, if you’re in the 25 percent tax bracket and negotiate to pay half a $5,400 balance, you’ll owe taxes of $675 on the unpaid amount of $2,700.
“The general rule is that anytime debt is forgiven, it’s considered income to you, like someone gave you a [cash] gift to repay the debt,” says Bill Smith, national tax director with the business consulting firm CBIZ MHM.
“It’s always going to be a good deal,” he says, because the tax bill is less than the amount of debt owed. “The problem is that it comes as a surprise because people don’t think they have to pay anything.”
Avoiding a suit
A negotiated settlement also prevents issuers from filing suit against you for the debt. If a suit were filed, you’d be responsible for the balance due and interest, which could accrue until the debt is repaid.
Larry Feinstein, a Seattle bankruptcy attorney, says that a majority of his clients who file for bankruptcy protection have credit card debt ranging between $30,000 and $80,000. Typically, a job loss or underemployment is the reason for the choking debt, and even if part of the debt is forgiven, people can’t pay it.
“A lot of them will come to me with these settlement offers for half the amount. But they say, ‘Where am I going to get that money?’ I’ve had very few clients who’ve been able to take advantage of these offers.”
Carole Fleck is a senior editor at the AARP Bulletin.