Does Using a Debt Settlement Company Ruin My Credit?

While debt settlement companies may make you lots of promises, such as cutting your debt by as much as half, you must use caution when dealing with such a company. Often, the way that debt settlement companies negotiate with creditors has a significant negative impact on your credit score. In addition, you may end up with even more debt than you started with.

Definition

Debt settlement is different from debt consolidation or debt management plans through credit counseling programs. The terms "debt settlement" and "debt negotiation" are used interchangeably. Where credit counseling companies work with clients to create a healthier financial plan overall, debt settlement companies focus only on cutting your existing debt, usually by withholding your payments from the creditors until they agree to reduce your payoff balance.

Damage to Accounts

As a result of the way that debt settlement companies conduct their business, you are risking your credit score by agreeing to work with one. Even if you're making payments to the settlement company, your creditors aren't seeing any of that money, and as a result your credit score will plummet. One of the top factors in calculating your credit score is your history of making on-time payments. Once you start paying the settlement company rather than your creditors, you likely will be viewed as having defaulted on payments.

Further Debt

When you make payments to the settlement company rather than your creditor, you may acquire hefty late fees and higher interest rates. According to the Federal Trade Commission (FTC), these fees may cause your debt to double or even triple. Additionally, most debt settlement companies charge high fees to establish an account, as well as monthly service fees and a final fee for a percentage of the money the service "saved" you. This additional debt will weigh heavily on your credit score.

Considerations

Working with a credit counseling company is far less risky than working with a debt settlement company, so consider getting in touch with a credit counselor first. If you are having difficulty making payments or have already defaulted on your debt, your credit counselor may recommend a debt management plan (DMP). Under a DMP, a credit counselor negotiates lower interest rates and/or payoff balances for your debt. The counselor then gives you a clear timeline, by the end of which your debt will be paid off. However, these negotiations are made while you continue to pay your creditors, and you begin making payments to the counseling company only after the agreements are made. The credit counseling company then pays your creditors. Although credit counseling companies are less risky, the FTC recommends checking with the National Foundation for Credit Counseling to ensure that you are working with a reputable organization (see Resource).