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How Does Credit Card Debt Arbitration Work?

written by: H. Rox•edited by: Donna Cosmato•updated: 7/6/2011

If you have fallen way behind on your credit card bills and have tried everything else, credit card debt arbitration -- another name for credit card debt settlement -- may be an option. But, this choice can have negative consequences.

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    If you're delinquent on your credit card bills, you might consider debt arbitration, also called credit card debt settlement or debt negotiation. However, settling your credit card debt in this way can have serious consequences. And, there are many scams out there. Learn how to reduce your credit card debt.

    What is credit card debt arbitration/debt settlement?

    Michael Smith, the president of SafeGuard Credit Counseling explains, it's when you agree to pay back part of what you owe to a credit card company. "Consumers can negotiate that debt down, sometimes more than 50 percent," he says, for example, from $10,000 to $5,000.

    How do you do it?

    Smith explains payback terms can vary, "Most of the time, consumers need to have a lump sum, or creditors won't negotiate. Other times, you can set up a payment plan." He says in some cases, people negotiate their own deals with a credit card company. In other cases, you can pay a debt settlement company to call off collection agencies and set up the credit card debt arbitration/debt settlement for you.

    Charles Delbaum, with the National Consumer Law Center, says credit card companies are approving "more settlements these days given our financial times." But he says some credit card companies will not work with debt settlement companies.

    Why would a credit card company agree to debt arbitration/debt settlement?

    Smith says after a certain period of time, credit card companies have to sell their bad debt. Often, he says they'll only get five cents for every dollar. If the credit card company can get the consumer to pay 50 cents on the dollar, through credit card debt arbitration, the card companies will lose less money.

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    Credit Card Applications

    Debt settlement can hurt your credit score.
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    But... (of course there's a "but", or everyone would do this)

    Delbaum says your credit report will suffer if you go through credit card debt arbitration/debt settlement. But, he adds, if a credit card company agrees to let you do debt settlement, you're already "pretty far delinquent" on payments, which would already be on your credit report.

    Plus, you may have to pay taxes on the money you got out of paying through debt settlement. You would use the IRS form 1099-C for that.

    Watch out for scams!

    If you need to go through credit card debt arbitration/debt settlement, Smith says find a reputable company to help you, check with the Better Business Bureau. Smith says SafeGuard is a non-profit credit counseling agency which helps people find other ways to get out of debt, they do not do debt arbitration. Both he and Delbaum say the credit card debt settlement industry is unregulated, and there are a lot of scams out there. All you have to do is a quick Google search to find many stories of people who paid credit card debt settlement companies lots of money, and got nothing in return.

    Other Options:

    If you want to try to lower your credit card debt without undergoing debt settlement, it's important to make more than your minimum payments. Many experts say you should try to pay off the card with the highest interest rates first. You may also want to switch to a card with lower interest rates. But at there could be fees involved. There also can be a downside to getting new credit cards too often, which could affect your credit score.

    Photo Credit: H. Rox