Posted by Elisabeth Leamy, Thu Jan 15 2009, 10:10pm

They may forgive, but they won't forget

They may forgive, but they won't forget. Banks are more willing than ever to forgive some of your credit card debt, but the non-payment will remain on your credit report for years to come, dragging down your credit score.

So what do you do? If you are in true financial peril, the brink of bankruptcy, you may want to approach your credit card company (or the debt collector assigned to the account) and ask to pay off less than the full amount. In this economic climate, some banks have been known to forgive up to 70-percent of a consumer's debt. Why? Not for your sake --for theirs. Banks fear that the economic downturn is only going to get worse in the coming months, so they're taking what they can while they can. They want to grab your limited funds before you send them off to some other credit card company.

The Financial Services roundtable, which represents all the big banks, even partnered with the Consumer Federation of America to try to come up with a broad loan modification program that could be applied across the board. For reasons I don't understand, the plan required approval from government regulators. And for reasons I really don't understand, regulators said no. So credit card companies are now negotiating with their customers one at a time.

Not just anybody can do this. Typically, you must be at least 90-days behind on your bill, but with a credit report that shows falling behind is not typical for you. If the bank won't actually forgive part of your debt, it may be willing to take smaller steps like lowering your interest rate or waiving late fees.

A non-profit credit counselor like Consumer Credit Counseling Service ( 800-388-2227) can help advise you on whether your particular situation warrants a loan modification. Credit counselors can also help you get some of the terms of your credit card loan revised. But to get the actual debt reduced you may have to get on the phone yourself.

Beware of for-profit debt settlement companies that offer to negotiate on your behalf. While it may be comforting to have somebody else do the dirty work, many of these firms charge a huge fee that eats into your finances right when you can least afford it. And some have been known to make huge promises to go along with that huge fee and then do nothing for you, leaving you further in debt.

OK, so I've told you how to go about negotiating a lower credit card debt. Now here's why you should only do so if your circumstances are dire. When banks forgive a debt it's called a "charge off" or a "write off" and it remains on your credit report for 7 years. (At least it's better than a bankruptcy which stays on your report for 10 years.) That black mark will make your credit score plunge.

Let's say your credit score dropped from a healthy 720 to a less flattering 680. Just 40 points. (It will probably drop more.) It's quite possible your other credit card companies will see you as a bigger risk and raise your interest rate with them.
If another card company raised your rate 10% on a $10,000 debt, it would take you 6 years instead of 4 to pay the card off and cost you an extra $7,700 in interest. (Assuming you pay $300/month.)

What if you wanted to refinance your $250,000 mortgage? With your new, lower credit score you wouldn't qualify for as favorable an interest rate. One scenario: instead of 5 and1/2 percent you would get a loan for 6 and 3/8 percent. And the mortgage would cost you $50, 473 more in interest over 30 years.

Bottom line: It's great news for certain debtors that credit card companies are willing to forgive up to 70% of debt. But if you don't really need to take such a drastic step, the repercussions will be brutal and you won't be able to forgive yourself.