Many people are confused about the best way to handle any cash they have when facing huge credit card balances. Should they pay off some cards and keep making payments on the rest? Or settle debts with the credit card companies for less than owed and save some cash for emergencies? Here is a typical scenario:

Q. I am a small home builder. I have good credit and always have. I have amassed most of my debt (90% of it) from the last house I built and took a $100,000 loss (on a $750K spec house). After the market crashed in Oct of 2008, I started to put items on my credit cards in order to finish the house (some in company name but attached to my ss #) to preserve cash and to be able to service the construction loan. Good thing I did.

I recently sold the house and have some cash to pay off the cards. I have $90,000 on 6 cards with $28,000 on another Visa (I think its run by BOA). I have never in my life even considered charging off debts. Now I feel that I have to look at all options. I am completely current on all payments. I realize that I have no leverage and do not want the late payments on my credit. As a builder I HAVE to have some capitol to work with so cannot just pay off all of the cards. Before I blow my cash, I have some very specific questions:

1. How much worse are late pays than a “settled for less than owed” on my credit report? Are we talking talking a 50 point FICO hit? 100?
2. I do not want to miss any payments and compound any problems that i may incur in the future but realize that gives me no leverage to induce a settlement….unless I tank on another house….in your opinion will they settle with impending doom?

A. My response:

1. I get asked this question all the time, “if I do X (insert action here: pay off cards, miss a payment, file a bankruptcy), how much will my credit score drop. My response usually runs along the lines of “if I knew, I’d be a millionaire”. The truth is, your credit score is dependant on many factors in your credit file. I’ve seen people with perfect payment history have scores in the high 600s and people with a couple of collections in the low 700s. You might want to read this credit scoring article to learn more what goes into a score.
2. If you settle with your credit card companies, they will put a notation on your credit card account that says “Settled for Less Than Owed”. This is the equivalent of a “Paid Chargeoff”, and is worse than late pays. That being said, In order to get credit card companies to deal with you, you’ll need to miss several payments which will incur late pays on your credit report. If you do a debt settlement with them, your late pay history may or may not be replaced with “debt settlement for less than owed”.

I know it’s tough to swallow a $100K loss. However, my personal opinion: if you really feel you need cash, then you should keep what you think you need, payoff whatever cards you can and make payments to keep current on the other cards . You need to protect your credit rating and think long term. Good credit is worth a lot of money.

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