If you are deep in debt and don’t see how you can ever climb out of it, you can get desperate. Now suppose you see a TV ad or get mail from a company that promises to reduce your debt to a fraction of what you owe, maybe even make it disappear completely. Tempting? Just remember, if it sounds too good to be true, it often is. With the average credit card debt on the rise again, its no wonder people are looking for debt settlement options.
The Promise of Debt Settlement Companies
Debt settlement can be a viable option and a last-ditch alternative to bankruptcy, but it can also be a scam. Debt settlement companies are much more regulated than they were at one time, but there are still risks. The promise is that the debt settlement company will negotiate with your creditors to accept an amount less than what you owe, usually in a lump sum. Often this involves credit card debt. Be aware that debt settlement companies cannot help you with debts that involve collateral such as car loans or mortgages. They also cannot help you with federal student loans.
The Downsides of Using a Debt Settlement Company
Debt Settlement Usually Takes Years
If you enter a debt settlement company program, it can take three or four years or even longer to settle. Debt settlement company customers are usually instructed to stop paying their debts and instead put the money into a savings account. You own the account and make monthly deposits of an amount agreed to with the debt settlement company. Since you are no longer paying your creditors, you become delinquent and your credit score drops significantly. Accounts that are delinquent and charged-off by creditors stay in your credit history for seven years. Your creditors could also sue you.
You Will Pay Typically 20-25% For The Service
The way it works with debt settlement companies is when you have deposited enough money into the savings account, the company will start talking with your creditors. Since they have not been paid anything for some time, the hope is they will be softened up enough to accept less than the full amount owed. If a settlement is reached, you pay in a lump sum or agreed upon installments. You then also pay the debt settlement company, typically from 20% to 25% of enrolled debt. Debt settlement companies are now forbidden by the FTC from charging upfront fees due to prior abuses.
Debt Settlement Companies Avoid Laws By Using Attorneys
However, there are debt settlement companies that still get away with charging advance fees by setting up a loose partnership with an attorney. This way, attorney fees can be used to justify getting some payment in advance. The FTC rule does not cover in-person meetings, so the debtor is directed to first speak with a local, affiliated attorney. The reality is that the attorney does not do any work to settle your debt. That is passed on to others in the company. Don’t be fooled by this ploy. It’s just a way to get your money when there is no guarantee of success, and if the company is successful, it will likely not be for years.
Debt Settlement Company Programs Are Often Unsuccessful
The Center for Responsible Lending reports that a substantial share of consumers are unlikely to settle enough debts to benefit from a debt settlement program. Some creditors will not even negotiate with debt settlement companies, though the debt settlement companies may not tell you that. A 2012 survey of credit card issuers, debt buyers, and debt collectors showed that only half of those surveyed would consent to negotiating with debt settlement companies. Instead, many creditors just sell the debts to collection agencies. In some cases, you may have better luck negotiating directly with your creditors.
Another reason debt settlement may fail is a debtor’s inability to complete the needed payments into the account set up for the purpose of settlement. These people are already under heavy financial pressure, and should they suffer another setback such as loss of a job or an unexpected medical expense, they may not be able to make their deposits. In this case, they are worse off than when they started, because they are delinquent for nonpayment and have racked up additional interest and penalties.
Interest and fees accumulate while you are paying into the savings account. If you cannot manage to stay on the program for the years needed to complete it, you will then have to deal with this higher balance. Neither will entering a debt settlement company program shield you from debt collectors. You will still face their collection efforts and possibly lawsuits.
Accumulating Interest and Penalties and Tax Obligations
For a case where debt settlement may be “successful,” consider that even if a debt is settled for 50% of the balance, because it takes so long, and because no payments have been made for years, the late fees and interest escalate the debt, so the settlement may actually be more than the original balance. Also, you must pay tax on the amount forgiven, something debt settlement companies are unlikely to tell you.
Any amount forgiven by creditors may be considered taxable as income. Debt settlement company customers sometimes don’t find this out until it is too late. There is an exception for insolvency, where your total debts are more than the fair market value of your total assets.
Alternatives to Debt Settlement Companies
DIY Debt Settlement
Before you turn to a debt settlement company, you could try talking with your creditors yourself to see if you can work out a resolution. Certainly, it’s cheaper, since debt settlement companies take up to 25% of what you owe. But it’s not for the faint of heart. It’s a great deal of work and involves the emotional strain of regularly dealing with debt collectors and creditors, perhaps for years. And whether you or a company do the negotiating, debt settlement will almost certainly damage your credit. Should you decide to try negotiating yourself, here are some tips.
- Be prepared with good records before you call.
- If you are turned down, it hurts nothing to try again.
- Know what payment you can manage and don’t agree to anything you can’t. That’s just putting off the inevitable.
- Call while there is still time. If you don’t pay on your debt for 180 days, your creditor can charge off your debt and sell it to a collection agency. This will cause your credit score to dive. Though settling for less than you owe will also cause a hit to your credit score.
- Before you approach your creditors, make sure you understand the tax ramifications. Consult with a tax accountant before proceeding.
- Try to find some cash to negotiate a lump sum settlement or at least a heft front-end payment. This will make your negotiation likely to be more successful. This may be the time to sell that coin collection or any property you can live without.
- Remember, you probably won’t be dealing with just one creditor. Most people in debt have multiple creditors. To avoid daily phone calls from creditors taking over your life, you might want to route collection calls to a separate number or assign collection numbers to a silent ring. Then once a day, you can pick up your messages and return the calls when it is convenient.
- Explain why you cannot pay the debt. It can’t be because you blew all your money at the track. However, if you have suffered unexpected medical expenses, a job loss or a natural disaster, creditors may understand that you really don’t have the capacity to pay the entire debt.
- Get all agreements in writing. If you reach an agreement with a creditor, get it in writing before you pay them anything.
Bankruptcy
Many people are afraid to file bankruptcy, because they are afraid to lose their assets. Contrary to what a debt settlement company may tell you, the reality is that most people do not have to part with any of their property. Speak with a good bankruptcy attorney about your situation. One advantage of a bankruptcy over debt settlement is that instead of it taking years, you can get it over with quickly and start rebuilding your credit. Filing bankruptcy also immediately stops harassment from debt collectors, creditors filing lawsuits and wage garnishments. Finally, the outcome, unlike debt settlement, is pretty much assured.
Debt management
You could contact a non-profit credit counseling organization for help. They can present you with different options. They may on the surface seem somewhat similar to debt settlement companies in that you may be able to make one payment to the organization, and they pay each of your creditors. But they will not advise you to not pay your creditors and become delinquent. Instead they may offer debt management options. They also might be able to negotiate better terms for you. However, these non-profits have your best interests at heart. Debt management can help you with credit card debt but not tax debts, student loans or medical expenses. See NFCC for a list of non-profit consumer credit counselors. Don’t be fooled by scam, for-profit debt management companies.
Debt Consolidation
If you can pay your bills but are struggling a bit, debt settlement is not the answer. You may want to consolidate your debts with a lower interest rate. You could do this with a personal loan or consolidate your credit card debt with a very low introductory offer.
Should You Ever Choose Debt Settlement?
Debt settlement is usually a last resort after your accounts are already delinquent and your credit score is already damaged. It won’t always work, but some creditors will accept a partial payment. If you think debt settlement is the way to go for you, you may want to try to negotiate with your creditors yourself before turning to a debt settlement company. But certainly, you should consider other options including consulting with a non-profit credit counseling organization before taking the risk of entering a debt settlement company program. You can check into a debt settlement company you are considering by contacting your state Attorney General and state consumer protection agency.
