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Overview
Settlement or bankruptcy

Negotiating with your creditors

Banks are willing to cut deals with cardholders who are at the brink

If you're struggling with credit-card debt, you have plenty of company. Total card debt in the U.S. is approaching $1 trillion, nearly 18 times higher than in 1980 and more than quadruple 1990 levels. But this tidal wave of debt also gives you negotiating power. Rising delinquencies and default rates have made card issuers more inclined to cut deals. You might be able to lower your interest rate, get penalties waived, or if your situation warrants, reach a settlement for substantially less than what you owe.

About 2.7 million Americans received some form of debt relief on their credit cards in 2008, the highest total on record, says David Robertson, publisher of The Nilson Report, a newsletter that tracks the payment industry.

Letting consumers settle their debts represents a complete about-face for many card issuers, according to a recent report by Innovest Strategic Value Advisers, an investment advisory firm in New York. "In the credit-card business, profitability is very often based on not being repaid," it said. "When borrowers run higher balances, they face higher finance charges and generate more revenues." The report estimates that credit-card defaults will reach $96 billion in 2009.

Until recently, cardholders faced with soaring finance charges on one card could postpone the inevitable by transferring the balance to a new card with a low introductory rate, or they could tap home-equity lines to pay down balances. The credit crisis has all but eliminated those options, so cash-strapped consumers must find other ways to reduce debt with the least damage to their financial standing.

Taking the initiative

Lynn Murphy of North Little Rock, Ark., was recently successful in getting a lower interest rate and other concessions from her card issuer. As her experience illustrates, getting your issuer to see things your way often depends on being persistent.

Murphy and her husband, Robin, had a balance of about $20,000 on a Bank of America credit card in August 2008 when its introductory interest rate of 3.99 percent expired and immediately surged to 17.99 percent. Most of the couple's card debt came from charges associated with their construction business, which took a dive along with the real-estate market. Instead of paying off monthly balances as they had in the past, they were only able to make minimum payments.

Murphy called a customer-service representative at Bank of America in fall 2008 to see if she could get a lower interest rate. She was told that even though she had a timely payment history, she didn't qualify because her credit report indicated that her debt-to-income ratio was too high. Instead, she was told she had to close the account and pay off the balance at the 17.99 percent rate.

It took three more phone calls before Murphy connected with a supervisor who said she qualified for the bank's hardship program, which slashed her APR to 4.5 percent. Her minimum monthly payment dropped from $495 to $390, which included finance charges of $84 rather than $290. That meant more of her payment would go toward reducing her balance.

The plan doesn't cause further damage to her credit score, and her debt will be paid off within five years rather than the 38 years it would have taken if she'd continued making minimum payments at the higher rate. Over that longer time period, she would have shelled out $30,000 in interest charges to pay off a $20,000 balance.

"If I hadn't called around, I'd still be paying nearly 18 percent interest," Murphy says. "So if the first person you call says no, politely ask to speak to a supervisor or someone in another department who might be able to help." She subsequently helped her brother negotiate better terms on two of his Citi credit cards, getting his interest rates cut by more than half and two $39 late payment fees waived.

The higher your credit score, the more leverage you have to bargain for better terms, especially if you indicate you're considering switching to another card with lower rates. In February 2009, the average APR was 8.29 percent for consumers with top credit scores of 760 to 850, and 12.76 percent for those with prime scores of 660 to 759. For consumers with subprime scores of 500 to 659, the average APR was 19.90 percent, while punitive rates imposed on those with black marks such as late payments averaged 27.76 percent.

Counselors can help

If you're seeking debt relief on multiple accounts, it's worth scheduling a free consultation with a credit-counseling agency that offers debt-management programs and budgeting advice. You can find such an agency through the National Foundation for Credit Counseling (800-388-2227).

A certified credit counselor can help you assess your options. For example, you might qualify for a debt-management program, in which you make a single monthly payment that the credit-counseling agency then allocates among your creditors to pay off your balances in full at reduced interest rates over time, typically three to five years for total card debt of $25,000 to $30,000. During that time, penalty fees and calls from debt collectors come to a halt.

Your credit score may suffer in the first year of the program, mainly because you must close the accounts you're paying off, but the damage is rapidly offset because most issuers begin reporting your account as paid on time after you've followed the program guidelines for a few months.

Depending on your financial circumstances, a debt-management program can be free or for a set fee (generally an enrollment fee of no more than $25 and a monthly fee of no more than $50). Nonprofit agencies can offer low fees because they receive grants or donations from major card issuers. In 2008, for instance, Bank of America provided $30 million in support to nonprofit credit-counseling agencies. It also participated with Capital One, Citi, Discover, and MasterCard in sponsoring the Web site Help with My Credit, which directs consumers to credit counseling.

From a card company's standpoint, having a cardholder agree to a debt-management program to repay balances in full is clearly preferable to the expense of debt collection or selling a delinquent account to a debt-recovery firm. For consumers, the primary benefits are reduced finance charges and minimal damage to their credit scores.

But for cardholders with high balances, those kind of programs aren't enough to get them out of trouble. "Ten years ago, $25,000 worth of card debt would have been considered the high end," says Gerri Detweiler, a consumer-credit expert and author of "Reduce Debt, Reduce Stress" (Good Advice Press, $14.95). "Now it's not uncommon to see cardholders with total balances that are double that." As a result, she says, quite a few people who contact counseling agencies find out that they can't afford the monthly payments a debt-management plan would require.

To address that problem, the NFCC proposed changes that would make the plans' fixed monthly payments more affordable while still getting consumers out of debt within five years. As of March 31, 2009, American Express, Bank of America, Capital One, Chase, Citi, Discover, GE Money, HSBC, U.S. Bank, and Wells Fargo had agreed to the proposed changes.

This article appeared in Consumer Reports Money Adviser.

Posted: June 2009 — Consumer Reports Money Adviser issue: June 2009