Although debt settlement companies promise to work out arrangements with your creditors allowing you to pay substantially less than what you owe, they do not always do what they promise. Entering into a contract with a settlement company has left some consumers in worse financial shape than before, owing large sums to the settlement company with little or no progress made on their debt.
Fees
It can be difficult to discover how much you will pay a debt settlement company, according to Smart Money. Companies vary in the way they compute the charges for their service. Some charge a percentage of your debt, and some charge a percentage of what they save you from paying. There are also sign-up and monthly fees added to your account. The service fees can be as high as 15 percent of your debt on top of the charges to settle your debt.
Higher Debt
It is up to your creditor to decide if it wants to settle your account and it can take years to settle. While the settlement company negotiates your debt, your creditor is adding interest and late fees to your balance. If the creditor does not accept a settlement offer, you can find yourself in deeper debt than ever before.
Tax Consequences
The Internal Revenue Service considers forgiven debt as income and expects you to pay taxes on it. Your creditor will send a Form 1099-C at the end of the year that informs you and the IRS of the amount it is claiming as a loss. You must claim this amount as income. If the amount is substantial, it could put you in a higher tax bracket that will increase the tax you owe on all income.
Negative Credit Reporting
Your creditors will report nonpayment to the credit bureaus where it will remain on your report for seven years. Even if the settlement company settles your debt, your report will report the settlement and payment issues. Negative reports lower your credit score, which results in higher interest rates on future credit if you can get it.
Considerations
You have the right to negotiate with your creditors yourself; you do not have to go through a settlement company. Start with calling your creditors and talking with them about your financial situation, they may have options to help. Free or low-cost credit counseling is available from many non-profit organizations. Counseling can help you decide the best way to handle your debt and teach you techniques that will help prevent future debt problems.
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