If you’re drowning in debt you can’t repay, your financial future might look bleak. However, you have several options that could help you reduce or eliminate your debt entirely. Depending on your situation, debt settlement might provide the help you need.
A debt settlement company aims to get your creditors to accept a lower amount than you currently owe. 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.
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Ways Debt Settlement Companies Can Help You
Debt settlement programs provide some advantages but also pose serious risks for consumers paying down debt.
Five advantages were outlined by debt settlement expert Kevin Gallegos, Vice President of Phoenix operations with Freedom Financial Network, one of the largest debt settlement companies in the U.S. Here are the key ways debt settlement companies can help you:
1. Provide Industry Experience
“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,” Gallegos said. 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 credit card debt settlement process reduces the total amount of your debt. In contrast, a debt management program might reduce the interest rate of future payments, but it won’t chop the principal amount 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.
4. Help You Avoid Up-Front Fees
You pay a fee to the debt settlement company in addition to your monthly payments. “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.
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.
Risks of Debt Settlement
Debt settlement programs might help some consumers eradicate their debt. However, government agencies such as the Consumer Federal Protection Bureau and the FTC warn that the process is fraught with risks.
Other industry experts concur. “Debt settlement companies should be avoided if at all possible,” said 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,” he said. 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.
More risks to debt settlement that you should consider include:
- Tax consequences: “If your settlement results in forgiveness greater than $600 (per creditor), you could receive an IRS 1099 at the end of the year and be taxed on the amount forgiven,” said Thomas Nitzsche, credit educator at Clearpoint Credit Counseling Solutions.
- No guarantee of success: 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’re having trouble dealing with debt.
- Increased debt: And even if creditors do agree to a settlement, if the debt settlement firm instructs you to stop paying your creditors while you accumulate your savings to settle debt later, it’s likely you’ll be hit with late fees and interest and other charges. You could wind up accumulating more debt than when you started. Debt collectors might continue pursuing you and worse, your creditors might sue you.
- Worsened credit score: Missing those payments and getting hit with those late fees could lead to negative effects on 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,” said Gallegos.
Alternatives to Debt Settlement
If debt settlement doesn’t seem like the right solution for you, you might want to check out some alternatives.
The main alternative to debt settlement through a debt settlement company is to negotiate on your own. “Individuals can try calling creditors and asking for temporary hardship status,” said Gallegos.
“The do-it-yourself approach will save you money perhaps more importantly, a lot of headache,” said Arnold. “It does require a bit more effort in terms of self-education,” he said. Clearpoint Credit Counseling Services provides “The Ultimate Debt Relief Comparison Guide,” comparing debt management programs, debt settlement, debt consolidation, and Chapter 7 and Chapter 13 bankruptcy.
Debt settlement is an option if you need help getting out of debt. However, there are many risks and unscrupulous providers. Plus, there’s no guarantee of success — and you could end up worse off than when you started. Check the extensive consumer information provided by the FTC before you sign up with a debt settlement company.