Let me be clear from the outset… there are not very many pros when working with a debt settlement company!
I understand that when you are buried in debt and feel you have no other option, that a debt negotiation or debt settlement company sounds appealing. But please, before you sign up for one of their programs, do your research (in other words… read this article).
Other than bankruptcy, debt settlement should be your absolute last option. Why? Well, let’s talk about why:
Purpose of a Debt Settlement Company
Don’t be fooled into thinking that a debt settlement company has your best interest in mind, or that they are trying to save you money. Like any business, they are trying to MAKE MONEY! How do they make money off someone who has thousands of dollars in debt? Well, simply put, they negotiate with your creditors a pay-off amount (typically around 40-50% of total balances owed) and then charge you a large fee on top of that amount, then create a ‘re-payment plan’ for you to pay off that newly negotiated balance owed.
Let’s look at a real life example:
I have a friend who had over $50,000 in credit card debt, and he told me that after speaking with a debt settlement company, this was the breakdown of the program and costs:
- Original Debt Balance: $52,954
- Monthly Payment Total: $1,663 (just paying minimum payments, which would take 30+ years to pay off).
- Re-Negotiated Debt Balance: $25,264 (roughly .50 cents on the dollar).
- Total Set-Up Fees: $549
- Reoccurring Monthly Fee: $39
- Fee to Debt Settlement Company: $8,790
- New Monthly Payment & Term: $988.31 monthly payment for 36 months.
On paper it looks great. Sure, you do have to pay the debt settlement company a big chunk of change, but you save $25k (it’s actually more if you factor in the interest that would have been paid), you almost cut your monthly payments in half, and you reduce the length of payments by 27 years. Sounds great to me! But, be careful.
How Will Your Credit Score be Affected?
Some of you may be thinking… I don’t care how my credit will be affected. You should! Understand that the way debt settlement companies work is… when you sign up for their program, they require you to STOP making your normal monthly payments to your creditors; instead, you deposit the money into an escrow-type account (if a company requires you to send the money to them, RED FLAG!).
Then, the company says they will begin negotiating a debt re-payment plan on your behalf with your creditors. Well, they do… they just wait about 6 months to start doing that. Why? Well, if you are current on your payments, why in the world would a creditor want to negotiate with you (or someone in your behalf) about reducing your debt amount or interest rate (again, these creditors have one purpose – MAKE MONEY. And the longer you make minimum payments, the more money they make).
So, if you miss your payments for 6+ months, how do you think your credit will be affected? Simply put, your credit will be destroyed! Eventually when (IF) everything works out with the debt settlement, your credit report will have ‘paid’ but not ‘paid as agreed.’ And that will be on your credit report (and thus affect your score) for 7-10 more years. So if your plan is to go buy a car or a house after your debts are paid, you’ll have two options:
- Not qualify for a loan (and given the fact you just got out of debt, you realistically won’t have a ton of extra money sitting around to pay for a house with cash)
- You qualify, but at a MUCH higher interest rate.
You’ll Probably End Up Paying For It
So, take our last example of buying a house at a much higher interest rate. Now you have a mortgage of $200,000+ and pay 4-5% more in interest over the life of that loan… you will certainly end up ‘paying for it’ later on by sacrificing your credit just to save a few thousand dollars with a debt settlement company. Get the picture. So, your short-term gain may result in long-term pain!
What Are the Tax Implications
The one thing that people who go down the debt settlement route always fail to realize is that any money saved from a debt settlement program is considered by the IRS income to you. That means that any amount of $600 or more is TAXED! You do the math… if your tax rate is 15% and you have $10,000 of debt forgiven, next April you are going to owe: $1,500.
The Creditors Don’t Stop Hounding You
Just because you are working with a debt settlement company, don’t expect for a minute that the creditors will stop hounding you. I’ll let you in on a little secret… most people drop out of debt settlement programs within a few months because of the stress caused by creditors constantly calling them, legal threats, and the realization that their credit is suffering while their debt settlement company is still just waiting for enough funds to accumulate to settle the debts (which in our example above, it is going to take a long time to generate enough money to pay off $25k in a settlement).
Also, if a creditor knows you are working with a debt settlement company, often they will escalate the account, which means that they send the account to a collections agency much sooner.
You Could Be Sued
Wow, this blog entry is not too uplifting is it! Hey, I’m just trying to educate you and help you understand the big picture of this whole process. Yes, technically, a creditor can take legal action and sue you. Remember that if a creditor takes legal action, the debt settlement company will drop the account because they can’t legally represent you or give legal advice. Wow! If this happens, you just spent how much money to a company who eventually did NOTHING for you, making you that much more in debt, having your credit suffer in the process, etc.
But, rest assured that failing to make payments on debt is not a crime in the U.S. and you won’t be sent to jail.
Do It Yourself
Think about it, the banks would much rather get something than nothing. Thus, they have every incentive to prevent you from filing bankruptcy, and instead, get you to pay even a portion of what you owe them. The bank just wants to get the loan off their books, and salvage as much money as possible (which becomes money they can invest with). If you know this, why do you need a debt settlement company? Sure, they are experienced in this and know how to deal with creditors; but, if you are actually behind on your payments and your credit is already impacted, then pick up the phone and start negotiating yourself rather than paying a company a large fee.
Tip: Keep in mind that creditors will not even talk to or negotiate with you unless you are about 6 months behind on your payments
Call your creditors and work out a repayment plan, renegotiate your interest rate, look into credit counseling, see if you qualify for a debt consolidation, etc. There is a lot you can do, and there are certainly better options out there compared to a debt settlement company.
Remember that working with a debt settlement company gives you absolutely NO protection, nor does it give you any guarantee that the program will work. The company may try to re-negotiate your debt, but if the creditors won’t go for it, not much you can do (and you’ve thus spent a lot of money to a company who has given you NO results, and your credit has been ruined in the process).
Also, keep in mind that later down the road, you may still be required to ‘pay in full.’
Avoid the “Sharks” in the Industry
Remember that settlement companies have only one goal: make money. Given the downturn in the economy, there have been many companies started to take advantage of the millions of people now in debt. Do your research, and know that there are some (few) companies out there that are reputable. You want to choose a company that has a TASC accreditation (The Association of Settlement Companies). Also check with the BBB, do research online, call companies, consult attorneys, ask your Attorney General’s Office, etc. Ensure the company you work with clearly outlines the fees, timeline, how your credit will be affected, what they do/don’t cover, what could go wrong, etc.
Well… Now What?
Let me be clear… if you are current on your payments, do NOT work with a debt settlement company. Honestly, the best advice I could give you is (and I know it sounds so simple)… go out and get a 2nd (or 3rd) job and make more money to pay down your debts. Avoid bankruptcy and debt settlement companies like a plague, and be willing to work a little harder to make more money to pay off your debts.
Never forget that your credit score is what is most important in the end. If your credit score is not affected yet, do EVERYTHING you can to keep it that way. Yes, I realize that this may mean it takes longer to pay off your debts, and you may end up paying more money in the end. But believe me, if your credit score remains good, then the extra money that you’ll pay in interest on your current debts will be far less than the extra money you’ll pay over your life because you have a good credit score (meaning future loans, interest rates, jobs offered, etc. will all be negatively impacted by a lower credit score).
If, however, your credit score is already ruined, you are months behind on payments, you can’t afford the payments anymore, and you have no way of making more money, etc… then learn more about your other options by reading the info on this blog about: debt consolidation, credit counseling, bankruptcy, etc.
