A reader named Brendan recently emailed me with a question about debt settlement. He explained that he was struggling with credit card debt, juggling balances of around 10 cards and paying only a little more than the monthly minimum (around $ 1,000 in total). He is particularly concerned because one of his card issuers recently reduced his credit limit from $ 12,000 to $ 2,000, which is the amount he currently owes. This increased her overall credit utilization rate from 45% to 60% and brought her credit rating down to 650.

Brendan says he earns about $ 65,000 a year and doesn’t have a lot of savings. The part of his email that worried me the most was when he wrote that he was strongly considering using a few more cards at most to purchase Visa gift cards. He worries about further reductions in the credit limit, so he says he could use the credit while he still has it, then he could either live off Visa gift cards for a while or sell them. . He is also considering paying off his debts for less than he owes, which he admits will have a major negative effect on his credit rating.

My advice

Brendan’s post began, “I thought I would drop a line before I do anything drastic with my credit here…”

Please don’t!

Accumulating extra balances with Visa gift cards is an especially bad idea. It could have legal consequences – it sounds a lot like money laundering – and violate Brendan’s credit card terms and conditions. It would also expose him to additional interest on purchases that he doesn’t have to make at the moment.

I often hear from people who seem to view debt consolidation as a magic wand. They’re probably in love with those TV commercials that promise to pay off your credit card debt for pennies on the dollar. Debt settlement companies often ask their clients to stop paying their bills for a period of time and then try to use that as leverage to negotiate a settlement. But there are several issues with the approach:

• Late payments dramatically lower your credit score
• Settling for less than you owe even more hurts your credit score
• There is no guarantee that this strategy will work.
• Even if this is the case, debt settlement agencies charge a fee and the debt forgiveness is often taxable.

Even after hearing all of this, some people persist. I guess the siren song of getting out of debt for next to nothing is too loud. They might also say that their credit is already low so they have nothing to lose. Or they’re not planning on applying for credit anytime soon.

For legal, credit, and ethical reasons, I consider debt settlement the last resort. It’s not as bad as bankruptcy. This reinforces the reason why credit card rates are so high (the national average is about 16 percent), especially in relation to secured debts like mortgages and auto loans. While credit card issuers have some options for recovering funds from delinquent borrowers, such as lowering your credit rating, suing you, and garnishing your paycheck, credit card debt is often the biggest debt. easy to pay in bankruptcy. That still doesn’t mean that jumping on is a good idea.

Non-profit credit counseling

I urged Brendan to find a way to pay back whatever he owes, even if it takes time. He owes about $ 17,000. For context, the Federal Reserve says 45% of US households are in credit card debt. The average amount is $ 6,300 and the median is $ 2,700.

A good place to start could be nonprofit credit counseling. Reputable nonprofit credit counselors, such as Money Management International and other agencies accredited by the National Foundation for Credit Counseling, will work with you and your creditors to develop a plan. These debt management plans often last three to five years.

They usually involve lower interest rates and just one monthly payment. Participants are often required to close affected credit cards, demonstrating behavioral changes that should be incorporated into a successful debt repayment strategy. I know this can be hard to hear, and I don’t want to shame anyone for their credit card debt, but making changes going forward is essential.

Root causes

Sometimes people go into credit card debt because of some unforeseen event, like a medical bill, a home repair, or a car problem. While these problems can be serious, they can be easier to resolve because they are isolated. This kind of emergency spending was the main explanation given by 35 percent of credit card debtors surveyed by our partner site CreditCards.com.

If you’re in credit card debt because your monthly expenses consistently exceed your income, as 26% of survey respondents reported, this is a more systemic issue you need to address. This will likely mean increasing your income (e.g. taking a sideline or finding a better paying job) or reducing your expenses (finding cheaper housing, selling a car, etc.). It might sound easier said than done, but any extra money you can funnel into your credit card debt makes a big difference.

Final thoughts

You can also ask your card issuers for lower interest rates or search for a low rate. Personal loan Where credit card balance transfer. But those approaches have all become more difficult as lenders worry about job security and the economy in the wake of the coronavirus pandemic. I think they will get easier once things get better, but for now, that’s why nonprofit credit counseling is at the top of my list of tips for someone who is bogged down. the weight of his credit card debt.

A question about credit cards? Email me at [email protected], and I would be happy to help.