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If you’re dealing with high amounts of credit card debt, you’re well aware of how difficult it can be to get rid of. For starters, the interest charges on your credit card debt can compound quickly, especially in today’s high-rate environment. Persistent inflation issues over the last year have also caused housing, gas and grocery prices to skyrocket, leaving many people strapped for cash. So, there may not be enough leftover in your budget to cover more than just the minimum right now.
As your credit card debt burden grows, it makes sense to look for alternative ways to tackle it. There are lots of options to consider, but for many, credit card debt forgiveness (or debt settlement) can be an attractive solution. The goal of these programs is to negotiate with your creditors to reduce your debt, allowing you to pay just a portion of what you owe.
But while debt forgiveness can provide much-needed relief, it comes with costs — some of which aren’t immediately apparent. So before enrolling, it’s essential to carefully weigh the potential expenses against the benefits to ensure it’s the right move for you.
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How much will credit card debt forgiveness cost you? Here’s what to know
When considering credit card debt forgiveness, the legitimate expenses you may encounter include:
Debt relief company fees
The debt relief companies that offer debt forgiveness programs typically charge fees for their services, which generally range from 15% to 25% of the enrolled debt amount. For example, if you’re trying to settle $20,000 in credit card debt, you could end up paying between $3,000 and $5,000 in fees alone. It’s worth noting that creditors aren’t required to settle your debts, either. This can leave you with partial debt resolution and additional costs over time.
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Tax liabilities
Another significant cost to consider is the potential tax liability of debt forgiveness. The IRS generally considers forgiven debt over $600 as taxable income. This means you might receive a 1099-C form and need to report the forgiven amount on your tax return, potentially resulting in a higher tax bill or reduced refund. For example, if you have $15,000 in debt forgiven and you’re in the 22% tax bracket, you could owe an additional $3,300 in taxes.
Interest and late fees
When you first start the debt forgiveness process, you stop making payments on the account and instead make monthly payments to the debt relief company, which is held in an account and later used for lump-sum settlement payments. In turn, the interest and late fees continue to accrue on your accounts. This can increase your overall debt balance, potentially offsetting some of the savings from settlement. A credit card with a 20% APR on a $10,000 balance, for example, could accrue an additional $2,000 in interest over a year.
Legal fees
There’s also the risk of legal action to consider. When you stop making payments, your creditors may pursue legal action against you — even if you’re enrolled in a debt forgiveness program. This could result in additional legal fees if you need to defend yourself in court, and any judgments against you could lead to wage garnishment or asset seizure.
Future borrowing costs
Your credit score is also likely to take a hit when participating in a debt forgiveness program. These negative marks can significantly lower your credit score and remain on your credit report for up to seven years, affecting your ability to borrow money at favorable interest rates in the future. That may not seem impactful now, but paying hefty borrowing rates after settling your debt can have a big impact on your finances.
How to lower the cost of debt forgiveness
If you’re considering debt forgiveness, there are several strategies you can employ to potentially reduce the associated costs, including:
- Negotiate on your own: Before turning to a debt settlement company, you may want to try negotiating directly with your creditors, as many are willing to work out a payment plan or settle for less than the full amount owed. This approach can save you the fees charged by settlement companies.
- Seek non-profit credit counseling: Many non-profit credit counseling agencies offer debt management plans at lower costs. They can work with your creditors to lower interest rates and create a manageable repayment plan.
- Prioritize debts strategically: If you have multiple debts, focus on settling the largest or highest-interest debts first. This can maximize your savings and potentially reduce the overall fees you’ll pay if using a debt relief company.
- Be cautious of upfront fees: If you do use a debt settlement company, look for one that charges fees only after successfully settling a debt. This aligns their interests with yours and ensures you’re not paying for services you haven’t received.
- Consider bankruptcy as an alternative: While it has its own set of consequences, bankruptcy might be a less expensive option in some cases, especially if you have a large amount of debt.
The bottom line
Debt forgiveness can be a smart avenue to consider if you’re dealing with compounding credit card debt that you can’t pay off on your own. However, there are extra costs to consider, so before making any decisions, be sure to do the math. You may find that the savings are substantial enough to justify enrolling, even with the extra fees, but in certain cases, it can make more sense to pursue other options instead.