How Debt Reduction Companies Work

The Basics

Debt reduction companies are firms that specialize in helping clients lower their debts without bankruptcy. These businesses, also known as credit counselors, work closely with their clients to help them develop new strategies for managing their debts. They aid them in creating a new budget they can live by, and also work directly with their creditors to reach an amicable resolution for debt repayment that does not require bankruptcy.

The Process

A representative of a debt reduction company calls each of the creditors on behalf of the client. He works out a payment arrangement that often reduces interest, waives over the limit and late fees, and reduces the amount of monthly payment. Some companies are also willing to reduce, or settle, the balance. The debt counselor does this until each unsecured creditor has been contacted and some type of agreement can be made. Some creditors may require the original terms be met, while others will work with the debt counselor.

Payments

Once the new payment plan is in place, the client makes one monthly payment to the debt reduction company. The company then breaks down the payment into what is owed to each creditor, and distributes it accordingly. The debt reduction firm usually charges an upfront fee to start the plan, and a small monthly fee to administer the program.

Advantages

There are several advantages to using a credit counseling service. One is the debtor does not have to file bankruptcy, which can affect his credit for seven to 10 years. In addition, most creditors will not make deals with individuals. They are more apt to work with companies, especially if it seems the debtor is sincere about working with the debt reduction firm to avoid bankruptcy. The client also saves some money by using the service.

Disadvantages

There are some disadvantages to working with a debt reduction company. Some unscrupulous companies have not managed payments properly, and caused more harm than good to their clients' credit ratings. Doing research in advance can prevent this from happening. Another is that debt reduction does not work for secured creditors, such as those for a car or home loan, because they can simply take back the collateral. In addition, a client's participation in debt reduction does show up on each affected account on a credit report. Most customers also must agree to not get any new credit, even a car loan, while participating in credit counseling programs.