This is the third part in a four-part series about Beth, who’s struggling to make monthly payments on her debt. I encourage people struggling with unaffordable debt to use this as a debt relief information guide. The focus of this series assumes your situation is past being able to apply conventional wisdom, like lowering monthly expenses and paying extra toward high-interest credit card debts.
In the first two parts of my email exchanges with Beth (a reader who submitted her questions to me offline, and who has given permission for me to publish our exchange as a learning tool, but with her name changed; we have also removed the names of her creditors), I focused more on eliminating options to manage her debt based on her lower income, which is also unstable because her current employment is temporary. If you are just starting out with researching your own path to manage problem debt, you may benefit from reading this series from the beginning.
In this part, her questions for me are keenly focused on negotiating lower payoff settlements with her credit card lenders.
Tomorrow I’m going to look for a bankruptcy attorney, however I’m more inclined to do a settlement at this point, that being said I have these questions:
- I have a checking acct with [one bank] where I currently have 2k [saved] and will have a little over 3k in 2 weeks; do I have to withdraw the money before trying a settlement with them? (I’m afraid they would freeze my checking and keep the money), if so should I open a checking acct with another bank? I’m assuming [a different bank] wouldn’t touch my money.
- If I’m successful, the settlement would save me $20k, will that be taxed? If so can you estimate the amount (roughly).
- What is the best way to negotiate the settlement with [one bank] and the others? For instance: I would offer 25% and they counteroffer 40% then I give my last offer 30% and if they don’t take it, I would then not make the payment for the first time ever and hopefully they will call me and take my 30% offer, would they call my bluff? And if they divide it into 3 payments can I try and negotiate 4-5?
- Can I be honest and tell them my plan to pay them: what I already have saved, plus what I’m going to make/or borrow from my parents?
- This may sound very dumb, but I have a $20k in my 401k, what if I withdraw about $5k, I know it would be heavily taxed, but is it something possible? I understand I’m not supposed to touch my 401k ever but in my situation it would save me interest and would be debt-free. What do you think?
If you could please take the time once again and I think I will be all set.
My Response to Beth
Those were really targeted questions Beth sent back. Here is how I responded:
1. I typically encourage moving to another bank if you have a checking or savings account with a bank that you will also be negotiating a credit card settlement with.
2.You can indeed be taxed on forgiven or canceled debt in excess of $600. Many people I have worked with over the years were able to meet the insolvency test, which meant they were fully or partially able to avoid any tax implications from debt forgiveness. I cannot hazard a guess at what your taxes would be. This is an issue you want to consult with a tax professional about. But if you determine you will owe any tax after settling, be sure that is part of your budget and planning.
3. The way you make calls to your creditors in the early stages of communication is one thing. You will typically not be offering to settle, or perhaps even be bringing up the subject until you are three to five months late with payments (unless they bring it up). I would not call my creditors and ask about settling for less than what I owe when still current, or not yet several months behind. It is a waste of energy, as the person answering the phone in these early stages may not be trained or authorized to even talk about it. In fact, and somewhat amusingly, you can call large credit card banks to talk about settling too early, and hear from the customer service rep that “we do not settle debts.” Read through the entire section about negotiating credit cards in the first stage of collection. You will be ready to talk with your creditors and negotiate your settlements when you finish.
You will typically not get your credit card banks to extend out payments — on the settlement amounts they agree to — for more than 94 days if they have not charged off the debt (taken the loss in their accounting books). Many banks might like to be able to offer their account holders that option (longer payment arrangements on settlements). But federal regulators have set guidance and policy that prevents them from doing that unless the account is charged off. Charge-off is one big determining factor banks use when they send accounts to outside third-party debt collectors and debt buyers, which is why settlements with monthly payments longer than a few months are often going to be achieved with debt collectors. There are often many opportunities to negotiate with debt collectors when your credit cards have just been charged off.
4. I find laying out your entire plan to negotiate and settle your debts with your bank or debt collectors to be counterproductive. They only care about the debt in front of them. Keep your focus to just the account at issue during any communications. If you mention other accounts, it is often just to say you are struggling with more than just paying them. They can see that because they typically have real-time access to your credit reports. When it comes time to have meaningful dialogue about what you can afford to pay as a settlement (which for you is not for many months), that is when you can bring up the fact that you are borrowing money from family to pay the deal if they agree to it.
5. Conventional wisdom says do not touch your 401(k) in this situation. That money is protected from creditors even if they sue you and get a judgment, and is also kept intact if you filed Chapter 7 bankruptcy. I am not all about conventional wisdom at all times. I have worked many cases over the years that were a great fit for borrowing against their 401(k)s. Yours is not one of those situations, in my opinion. That is something I would look closer at when there are complex assets, security clearances (work in finances, military contracting, etc.), or similar circumstances. Your path to successfully settling your credit cards looks straightforward to me.
Over the years of doing these types of consultations with people (primarily on the phone), and when encouraging people to understand they can negotiate settlements with creditors and collectors on their own, I have often repeated this: Debt settlement is not rocket science, but there is a formula to follow. That formula is 90% investing the time to become informed about what debt negotiation is, and how and when to get things accomplished. It took Beth and me three days and several emails to get to this point. But Beth also invested more time into reading up on her options in more detail.
In the next, and final, part of the series, you can see how Beth became more serious about doing something that I teach every person in the midst of a debt triage situation to do. Stay tuned.
More on Managing Debt:
- 5 Tips for Consolidating Credit Card Debt
- Understanding Your Debt Collection Rights
- The Best Way to Loan Money to Friends & Family