After a windfall, do you negotiate debt? Or just pay down balances?

Tanisha Warner
August 27, 2012

Dear Credit Care,
I came into some money and want to pay off a couple of my credit cards, but don't have enough to pay them off in full. What is the best way to ask them to reduce your payoff amount? -- Julie

Dear Julie,
Unless you are seriously behind in payments on your credit card accounts, it is doubtful your card issuers will agree to settle an account for less than the full balance owed. That said, if you haven't made a payment on the accounts in 90 days or more, your card issuers may be willing to settle for a lump sum payment to satisfy your account. Contact them and ask to speak to someone who is able to negotiate a less-than-full-balance settlement on the account. If you are able to negotiate an amount you can afford, be sure to get the settlement offer in writing before you send in the payment. Be aware that if you settle the account, the card issuer will in most cases close the account.

You may face one other issue if you settle an account for less than full balance. The card issuer is required to issue you a 1099-C tax form if the amount of debt forgiven is $600 or greater. For example, if you owe $6,000 and you settle the account for $4,500, the amount forgiven is $1,500 and you would be issued a 1099-C in that amount. What that means for you is that the Internal Revenue Service looks at the $1,500 that you owed, but did not pay, as income in the year in which it was forgiven. You will be required to add any amounts on 1099-C forms issued as a result of paying less than the full amount owed to your total income for 2012 when you file your income taxes. Depending on the amount of taxes you have withheld from your paycheck each month, you could owe the IRS as a result of the forgiven debt.

Should you not already be very delinquent on your accounts, but want to try and negotiate with your card issuers anyway, I want you to be aware of the consequences to your credit in the unlikely event that you are successful. If the accounts are up to date and currently being reported as positive items on your credit reports, settling the accounts could cause a big decrease in your credit score of as much as 100 points in some cases. Because you don't know when you might need your credit reports and scores to look their very best, taking a hit to your credit like this may not be worth it.

A better idea might be to pay down your credit balances with the windfall that you have and then aggressively pay off the much-lowered balances until they are paid in full. You might also consider saving a portion of the money in an emergency savings account. When you have money saved, you won't have to rely on credit for unexpected expenses and can keep those credit card balances down.

Handle your credit with care!   

See related: 8 myths about settling credit card debt ,  1099-C surprise: IRS tax follows canceled debt