A proliferation of ads promising to erase debt has lured overburdened consumers into striking deals that may leave them in worse financial shape. The culprits are debt-settlement companies that negotiate deals with the creditors in the hope that the creditors will settle for lump-sum payments of less than they're owed. The debt-settlement industry is largely unregulated, according to the Federal Trade Commission, so make sure you understand the process and its risks before you enter into an agreement with a debt-settlement company. You also can attempt to reach a debt settlement with your creditor on your own, without the assistance of a debt-settlement company.
How Debt Settlement Works
If you choose to try to settle your debt through a debt-settlement company, the company you hire usually will advise you to stop making payments to your creditors. Instead of paying your creditors, you'll make monthly payments into a special account the debt-settlement company maintains on your behalf. Once you've amassed enough money to encourage your creditors to settle your debts, the debt-settlement company will attempt to negotiate payoff amounts of less than your balances. If the creditors agree, the debt-settlement company pays the creditors from your account.
Risks of Debt Settlement
The debt-settlement process can take many months, or even years, and there's no guarantee your creditors will settle. In the meantime, late fees and interest continue to accumulate, the number of days past due shown on your credit report continues to increase, and your creditors may continue their collection efforts. In addition, the debt settlement company collects its fee from your payments into the settlement account. You'll likely pay the company a monthly fee, and you may have to pay a percentage of the savings you reap by settling. This is money you otherwise could have used to pay down your debt. If the creditors refuse to settle, they can sue you. Although the debt settlement company won't defend you in a lawsuit, it might use the money in your settlement account to hire an attorney on your behalf. In this case, according to the Iowa Department of Aging, you'll have to decide whether to defend yourself against the lawsuits or negotiate payment plans with your creditors. Even in a best-case scenario, in which you save enough within a reasonable period for the debt-settlement company successfully to negotiate settlements with your creditors, the creditors may report to credit bureaus that you settled for less than you owed. Although these notations damage your credit less than bankruptcy would, they're still serious blemishes. You'll also have to pay income taxes on the difference between your credit balances and your settlement amounts.
Alternatives to Debt Settlement
The first option is to work with your creditors to find a solution to your difficulty in keeping up with your payments. The creditors may reduce your interest rates or lower your payments by giving you extra time to pay off your balances. If you're unable to negotiate a plan on your own, seek help from a nonprofit credit counseling agency to create a debt repayment plan. Under such a plan, you'd make one monthly payment to the agency, and the agency would disburse it to your creditors. Credit counseling agencies charge lower fees than debt settlement companies do. In addition, because many creditors fund credit counseling agencies in an effort to avoid bad debt, the chances are good that your creditors will work with the agency. If you're forced to drop out of the program because you can't keep up with your negotiated payments, you at least will have paid down some of your debt. You also can contact your creditor directly and attempt to reach a debt settlement for a lump-sum payment that is less than the total amount you owe.
Choosing a Reputable Debt Settlement Company
If, after weighing the risks and considering your options, you decide to work with a debt-settlement company, make sure you can cancel your agreement and receive the money in your settlement account if your creditors sue you or refuse to settle. The debt-settlement company probably won't refund fees you've already paid, however. In addition, the company should offer full disclosures about the risks and limitations of settlement. Finally, check with the Better Business Bureau and your state attorney general's office to inquire about complaints made against any company you're considering hiring.
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