Ask Liz Weston

Dear Liz: Lots of “credit card remedies” are being marketed now. Is debt settlement a reasonable way to reduce debt? I have a good track record of payments and good credit scores (my median FICO score is 745). I’m concerned I’ll damage my creditworthiness for years to come.

Answer: Debt settlement means you’re paying less than you owe — and creditors really don’t like that. Debt settlement can trash your credit, which is why it isn’t a good option if you can find other ways of dealing with your debt.

If your interest rates are relatively low and you can easily make your minimum payments, your best bet is to simply pay off the debt on your own, throwing as much money as possible at your highest-rate card while paying the minimums on your other debt. Once your highest-rate debt has been retired, you can apply that payment to your next highest-rate debt, and so on until you’re debt free.

Or you can transfer your debts to a fixed-rate personal loan and pay that off over time. Many credit unions offer three-year personal loans at rates of 10% to 15% to people with good credit.

If you’re struggling to make your minimum payments, you should arrange two appointments: one with a legitimate credit counselor (you can get referrals from the National Foundation for Credit Counseling at www.nfcc.org) and another with a bankruptcy attorney.

The credit counselor may be able to put you on a debt management program to pay off your debt at lower interest rates. Credit counseling is a neutral factor in credit scoring formulas — neither helping nor hurting — but your creditors may report you as late, which could hurt your scores.

Bankruptcy would really trash your scores, driving them down into the 500s. But it could wipe out your debt and give you a fresh start if you aren’t able to pay your bills.

What you want to avoid, if possible, is raiding retirement funds or home equity to pay credit card debt, particularly if bankruptcy may be an option. Retirement funds are protected in Bankruptcy Court and so, in many cases, is home equity.

Legitimate credit counselors have long been frustrated with most credit card issuers’ unwillingness to sufficiently cut interest rates or provide other relief to troubled borrowers.

People would try to sign up for the counselors’ debt management programs, only to discover they couldn’t make the payments credit card companies required and their only real option was bankruptcy.

The problem has become more critical as more people sink deeper into debt and often have less income to pay what they owe.

Last fall, the leading credit counseling organization–the National Foundation for Credit Counseling–formerly called on creditors to take additional steps to make debt management plans more affordable.

Today, the NFCC announced the creditors had come through. All top 10 of the nation’s credit card issuers agreed to provide additional relief to troubled borrowers by waiving fees, lowering interest rates and accepting smaller minimum payments.

What that means for the typical credit counseling customer who owes $24,000 on credit cards is a payment as low as $420 a month, versus the $540 that would have been required earlier.

If you’re having trouble making your minimum payments and trying to avoid bankruptcy, a call to an NFCC-affiliated agency may be in order. But also discuss your situation with a bankruptcy attorney to see if starting fresh may be a better option.

For more, read:

• The consumer’s guide to credit counseling
• Get a credit card reprieve
• 15 steps if bankruptcy is inevitable

I’ve heard from two readers in recent weeks who called Bank of America to ask for a lower rate on their credit cards–requests that seriously backfired.

The first knew his credit wasn’t great, but thought he’d see if BofA would lower his 25% rate anyway. Not only did the bank say no, it lowered his credit limit by $7,000.

The second asked BofA “what I could do in these difficult economic times to reduce my interest and/or payments” on a credit card and a line of credit, according to a post on the Your Money message board.  Instead of a concession, the reader recently received letters from the bank saying the accounts had been frozen. “I was very surprised and called Bank of America again regarding the letters,” wrote the reader, who wasn’t in financial distresss. “Their response was that since I called to ask them for help it showed I was in financial hardship and froze my accounts.” 

Bank of America spokeswoman Betty Reiss said it’s not the bank’s policy to freeze or shut down accounts simply because customers ask for an interest rate cut. But she sidestepped my question about whether such requests invite the bank to more closely scrutinize the accounts. Bank of America is more closely monitoring all its accounts these days, she said.

Here’s what you need to know about asking your issuer for a lower interest rate:

You have the best shot if your FICO scores are 720 or above. Credit card issuers are trying to shed high-risk customers but woo (and retain) low-risk ones.

Don’t cite “hard times” unless you’re facing them. If you have good scores, you want to argue from a position of strength–”I have great credit and can easily take my business elsewhere.” If you talk about economic distress, you’ll set off red flags and alarms.

If your scores aren’t great but you’re not in distress, consider other options. Rather than asking for concessions from your issuer, talk to your local credit union about a fixed-rate debt consolidation loan. Consider a 401(k) loan only if your job is rock-solid.

If you are facing distress, get help. Your issuer may offer you a modified repayment plan or temporary forbearance (read this excellent CreditCards.com story for details), but your accounts will almost certainly be frozen and perhaps shut down. Credit counseling is another option that will have the same result. Bankruptcy is a last-resort option that may be your only way out if your debt is truly unpayable; consult an experienced bankruptcy attorney fordetails.

Dear Liz: My spouse’s siblings have decided my husband and I should lend his brother $11,000 to pay off three credit card bills since they “can’t.” He says the interest rates are killing him and that he can afford to pay us $200 a month. In the past, whenever this brother had money issues, his parents took care of them, bailing him out more than once. My spouse feels obligated to his family, but I see it more as being used and expect never to see the $11,000 again. If we have to go through with this, I’d prefer to have a formal legal document with some protection and collateral. I’d also like to have it written that the credit card accounts are closed and no more will be opened while the loan is being repaid. I’ve wondered if there isn’t a better way to do this safely.

Answer: How nice of your husband’s family to decide how you should spend your money. But just because you appear to be better off than they are does not mean you are obligated to support the family spendthrift.

The situation might be different if your brother-in-law’s life or health were at stake, or if he suffered an unexpected financial blow. In that case, you might want to honor your spouse’s sense of obligation (while perhaps persuading the other siblings to chip in).

In reality, however, what we have is a grown man who can’t figure out how to pay an $11,000 bill without pleading with his siblings for a bailout.

Your spouse should recommend he talk to a legitimate credit counselor about a debt management program that could lower his interest rates. He can get a referral from the National Foundation for Credit Counseling at www.nfcc.org.

If you do lend the money, you of course should formalize it with a written agreement and collateral. But understand that regardless of the precautions you take, the chances of his actually repaying the loan are slim.

You also shouldn’t imagine that the shame of the unpaid debt will deter him from asking for more money the next time he gets into trouble. This man never learned self-reliance, and you won’t teach it to him by giving him more money.