If you’re drowning in debt, your financial future might look bleak. Learning about the options you have can help you avoid ridiculous attempts to pay off your debt. Depending on your situation, debt settlement might provide the help you need.
A debt settlement company negotiates with your creditors to accept a lump sum payment that is less than the debt balance owed. You’ll make monthly payments to a third-party savings account. Once you’ve accumulated enough cash, those funds will be used to pay off the negotiated amounts. Debt settlement programs provide some advantages but also pose serious risks. Here are six ways debt settlement companies can help you:
1. Provide Industry Experience
If you find yourself in deep debt, you might not have much experience dealing with creditors to become debt free. Working with a debt settlement company can put that experience on your side.
“A good debt settlement provider will know how much each creditor is willing to settle for, and what terms they will agree to at different points in the process,” said Kevin Gallegos, vice president of Phoenix operations with Freedom Financial Network. In contrast, an ordinary consumer who tries to negotiate his own debt relief might end up with a bad deal.
2. Lower Amount of Your Debt
A successful debt settlement process reduces the total amount of your debt. On the other hand, credit counseling services will usually reduce your payments but not the total principal amount you owe. In order to make a large amount of debt more manageable, look for a company that can reduce the amount of debt you owe.
3. Reduce Multiple Debts to a Single Monthly Payment
Instead of dealing with payments each month to each creditor, you pay one monthly sum to the savings account. That way, you can focus on one payment each month so you don’t rack up late payment fees just because you’re overwhelmed with costs
4. Help You Avoid Up-Front Fees
When you work with a legitimate debt settlement company, the Federal Trade Commission prohibits the company from charging you any fees before your debt is settled.
“Federal Trade Commission rules state that fees can be charged only after the firm has successfully negotiated the debt on terms the customer accepted,” said Gallegos. “Reputable debt settlement firms will abide by the FTC regulations, and not require any up-front or monthly fees. Fees should only be paid on the basis of results,” he said.
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5. Prevent Personal Bankruptcy
If you can successfully settle your debts, you might be able to avoid filing for bankruptcy. Although debt settlement has drawbacks, personal bankruptcy is the last-resort option. Your credit score will suffer if you take either path, but you might feel bankruptcy confers social stigma as well.
6. Create a Plan to Reduce Debt
If you don’t have any idea on what to expect from dealing with creditors, working with a legitimate debt settlement company will give an idea of what to expect up front. Prior to signing up, the debt settlement company must tell you all of the following:
- All fees and conditions of the debt settlement company’s services
- How long the debt settlement company will take prior to making debt settlement offers to each of your creditors.
- The offers the company will make to each creditor
- If the debt settlement company will ask you to stop making payments to your creditors and if so, any negative consequences of not paying such as interest, penalties, and impact on your credit score
Risks of Using Debt Settlement Companies
Though debt settlement companies can help in some circumstances, using even the best debt settlement companies comes with substantial risk. Government agencies such as the Consumer Federal Protection Bureau and the FTC warned that the process is fraught with risks.
“Debt settlement companies should be avoided if at all possible,” noted Curtis Arnold, credit card expert and founder of CardRatings.com. “The industry has many bad apples and the few good apples typically charge high fees. Although you’ll pay a lower total amount to your creditors when settling credit card debt, the debt settlement companies don’t work for free. They often charge high fees, possibly based on the amount they saved you.”
First, beware of scams — such as if the company guarantees it can settle your debt for pennies on the dollar, tells you to ignore your creditors without informing you of the consequences, promotes a “new government program,” or requires that you pay them up front. Other risks include:
- Tax Consequences: Depending on your financial circumstances, any debt creditors forgive could count as taxable income. So, you could be trading debt elimination for a tax bill.
- No Guarantees: Despite the promises debt settlement companies might make, there’s no guarantee of success with debt settlement — and you could still increase your debt and ruin your credit. Creditors aren’t required to negotiate, even if you legitimately can’t pay your bills.
- Fees Could Exceed Savings: Between the fees that the debt settlement company charges and additional interest and penalties you rack up not paying your creditors, the total costs could exceed any savings.
- Credit Score Damage: When you stop making payments on your debts, your credit score will be damaged. Plus, if the debt settlement company does succeed in getting your creditor to accept less than you’re owed, that debt forgiveness also hurts your credit score. “While enrolled in a debt settlement program, a consumer will be delinquent on the enrolled debts which will appear on credit reports,” added Gallegos.
Alternatives to Debt Settlement Companies
Before signing up with a debt settlement company, make sure you consider other debt relief options so you can weigh debt settlement pros and cons. Alternatives to debt settlement companies include:
- Negotiate With Creditors Yourself: You don’t have to have the experience to call up your creditors and try to negotiate your debt yourself. “Individuals can try calling creditors and asking for temporary hardship status,” Gallegos noted. “The do-it-yourself approach will save you money, and perhaps, more importantly, a lot of headaches,” said Arnold. “It does require a bit more effort in terms of self-education,” he said.
- Credit Counseling Services: A credit counselor can help you take control of your financial life and help you as a debt payoff planner. Credit counseling companies are usually non-profit companies. They work to lower your overall monthly payment that you will pay over a longer period of time. A Credit counseling company will work with you to come up with a debt management plan to solve your financial issues.
- Bankruptcy: Bankruptcy is generally a last resort for dealing with your debt. Chapter 7 bankruptcy discharges your debt, but except for limited exceptions, all of your assets are taken to pay your creditors. Chapter 13 bankruptcy allows people with an income to keep certain property, like a house or car, and to pay off debts over several years.
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Valerie Rind contributed to the reporting for this article.