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9 credit card debt settlement mistakes to avoid

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The right debt settlement program could help you get rid of your credit card debt — but be sure to avoid these common mistakes. Getty Images

Many Americans are struggling financially right now due to the current economic climate, in which rampant inflation has sent the cost of living upward, causing prices on essentials like food, gas and housing to climb significantly. At the same time, the Federal Reserve has kept interest rates at a 23-year high in an effort to get inflation under control, making borrowing far more expensive than it has been in the last several years.

This mix of elevated rates and high inflation has put millions of households in a precarious position. As disposable incomes get squeezed tighter and tighter, it has become challenging to cover both necessary living expenses and outstanding debt payments. And, perhaps unsurprisingly, the number of people falling behind on their credit card bills has spiked over the past year.

For those grappling with mounting credit card debt, a credit card debt settlement program can seem like an attractive lifeline. With this type of program, a debt settlement company negotiates with your creditors to allow you to pay off your debts for less than the full amount owed. While settling your debts for a lower lump sum can provide much-needed relief, there are some potential pitfalls to avoid.

Drowning in credit card debt? Compare your debt relief options now.

9 credit card debt settlement mistakes to avoid

If you're planning to enroll in a credit card debt settlement program, make sure to watch out for these big mistakes:

Choosing a disreputable company

The debt settlement industry has its fair share of bad actors looking to take advantage of vulnerable consumers. So, doing your due diligence to find a reputable, trustworthy debt settlement firm is essential. As you search for the right debt relief company, be sure to check reviews, verify credentials and accreditations and have an in-depth discussion about fees and processes before signing any agreements.

Find the best options for tackling your credit card debt here.

Believing debt settlement is a quick fix

Contrary to how it may be portrayed in certain cases, debt settlement is not an overnight solution to your credit card woes. The negotiation process takes many months (at a minimum), during which time you may face escalated creditor calls, potential litigation threats and continued credit score damage. So, maintaining patience and discipline is key during this process.

Stopping your debt payments too soon

One key tenet of debt settlement programs is that you stop making payments to your creditors for a period of time and instead make monthly payments to the debt settlement company. This money is held in a special account, allowing funds to accrue that can ultimately be used as a lump sum settlement offer. However, you'll want to ensure you have explicit approval from your debt settlement company before halting payments, as stopping too soon can severely damage your credit score.

Failing to understand the tax implications

When you settle a debt for less than the full amount owed, the forgiven portion is generally considered taxable income by the IRS. Neglecting to plan for this potential tax bomb can lead to an unpleasant (and costly) surprise come tax season. To avoid the potential repercussions, you may want to consult a tax professional to better understand your specific situation.

Not having a plan for new debt

One of the most common pitfalls of debt settlement is that consumers fail to change the financial habits and behaviors that landed them in debt trouble in the first place. That's why you must have a concrete plan for avoiding the accumulation of new debt while working through your settlement program and beyond. Otherwise, you run the risk of falling into the same debt issues that you were facing before the debt settlement.

Overlooking creditor concessions

Some creditors may be willing to accept affordable payment plans or reduced interest rates simply by asking, and that may happen without the need for a debt settlement program at all. In turn, you may want to exhaust these options before pursuing debt settlement, which can have a negative impact on your credit score, at least temporarily.

Ignoring the statute of limitations

Most states have statute of limitations laws that restrict the time period during which a creditor can attempt to collect a debt. If you make a payment on an old debt, even a small one through a debt settlement program, you may inadvertently restart the statute of limitations clock. So, before embarking on a credit card debt relief journey, make sure to understand these laws inside and out.

Failing to get agreements in writing

Verbal agreements regarding settlement amounts should never be considered final. Insist on getting every single term and condition of your debt settlement in writing before finalizing or making payments instead. Otherwise, you may find yourself in an untenable situation.

Being lured in by grandiose claims

Finally, be wary of debt settlement companies making grandiose claims about the amount of money they can save you. While negotiating to pay creditors pennies on the dollar is theoretically possible, more modest 25% to 50% reductions are far more common. In other words, be sure to have realistic expectations from the outset.

The bottom line

While credit card debt settlement programs can provide much-needed debt relief for some, failing to avoid these potential errors can quickly turn a financial lifeline into another headache. So, while debt settlement programs can make sense in a lot of situations, doing your homework and understanding all the implications is critical before embarking on this path.

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