“Debt free in 24-48 months.”
“Resolve debt with one low monthly payment.”
“Credit card debt in control of you? Get free quote and end your stress!”
“Reduce your debt up to 65 percent.”
These quotes are taken from ads posted by debt settlement companies. For millions of Americans who are crippled by large debt, it can be tempting to want to utilize the services of a debt settlement company. Who wouldn’t want to have their debt resolved with one low monthly payment? Or have their debt reduced by 65 percent? If you’re considering using one of these companies, though, don’t let the eye-catching advertisements fool you. Familiarize yourself with the dangers of debt settlement companies.
It’s no secret that Americans love to swipe their plastic. More than 160 million Americans have credit cards. The average U.S. household with a credit card carries more than $15,000 in credit card debt. And total U.S. consumer debt — including mortgages, auto loans, credit cards, and student loans — exceeds more than $11 trillion. Weighed down with so much debt, it’s not wonder why some Americans may turn to the services of a debt settlement company.
Why debt settlement companies don’t seem so bad at first
At first glance, debt settlement companies might not appear so bad. You just pay the debt settlement company to pay your creditors — and eventually you’ll get out of debt. But you need to remember that debt settlement companies are for-profit firms and charge fees as they arrange settlements of your debts with creditors or debt collectors.
A common way these companies work is that they advertise low payments to get rid of your debt in a specific, even short, amount of time. If you have a large amount of debt, say $10,000-15,000, a debt settlement company might catch your eye with advertisements that promise to resolve your debt with low monthly payments, but that money doesn’t actually go to creditors right away. Instead, it goes into a special account. The company takes its fee — as much as 15-20 percent of the debt — out of that account.
Fees and other procedures
What’s more, the company might charge 2-4 percent of the debt for setup costs (some even charge as much as 15 percent), monthly service fees, and a contingency fee on the amount you’ve “saved” if a settlement is reached. Meanwhile, money is drained from your savings account and your debt isn’t reduced by a single penny until enough money is collected in the special account.
Once enough money is accumulated, the debt settlement company calls the creditor and begins negotiating. It might successfully manage to settle your debt, it might not. Before you know it, you’ve lost hundreds or thousands of dollars in fees and find yourself in an even bigger hole than when you first turned to the debt settlement company.
Debt settlement companies will ask you to set aside a specific amount of money every month to transfer into a special savings account — eventually accumulating enough money to pay off a settlement that is reached. Here’s the thing about these companies, though. Oftentimes you’ll be asked to deposit money into an escrow-like account for 36 months or more. Chances are that if you’re turning to a debt settlement company in the first place, you’re worried about your debt spiraling out of control. You might not be able to afford the minimum payments in the first place, let alone save money to pay off the debts in a special account.
Red flags and extreme tactics
Another red flag to worry about: Debt settlement companies often have no up-front agreements with creditors. In fact, creditors are under no obligation to negotiate a settlement on your debt. So before you pay to utilize a debt settlement service, be aware that creditors and debt collectors might not negotiate with the company in the first place. And some creditors might even intensify their collection efforts if they find out that you’re working with a debt settlement firm.
Perhaps the most egregious tactic debt settlement companies use is the way they encourage consumers to stop sending payments to creditors. Think about that for a second. Does it really make sense to stop paying your debt off when you’re seeking help for your large debt load? If you stop making payments on your debt, you will face late fees and penalty charges, not to mention the creditor might still come after you to collect. Stopping payments will only cause your debt to grow larger — not to mention negatively affect your credit report. Be wary of any company that asks you to stop making payments on your debts.
The Federal Trade Commission says you should avoid doing business with a debt settlement company if it charges any fees before it settles your debts, touts a “new government program” to bail out personal credit card debt, guarantees it can make your unsecured debt go away, tells you to stop communicating with your creditors (but doesn’t explain the serious consequences), tells you it can stop all debt collection calls and lawsuits, or guarantees that your unsecured debts can be paid off for pennies on the dollar.
What if your debt gets settled?
Even if a debt settlement company manages to settle your debt with creditors, your credit report will suffer and it could take months or years to get approved for new lines of credit. Moreover, you could owe taxes on the settled debts. That said, while many debt settlement companies are scammers, not all are bad. Just be sure you know what you’re getting into before you decide to use the services of one.
If you feel like your debt is spiraling out of control, you must take action before the problem worsens. You can manage your debt through a number of strategies that will help you slowly pay your debt down. If you’re thinking about getting relief for you debt, though, consider using a credit counseling service. Credit counselors are usually nonprofit organizations that advise you on managing your money and debts and help you budget your payments. Unlike debt settlement companies, they typically reach up-front agreements with your creditors to ensure that the creditors will not pursue collection efforts or charge late fees. They usually don’t negotiate a reduction in the amount you owe, but can help negotiate a lower overall monthly payment. You can find a nonprofit credit counselor through the National Foundation for Credit Counseling.
Alternatives to think about
Another tactic you might consider — negotiating directly with the creditor yourself. Politely explain your situation to the creditor and try to work out a modified payment plan. You might be able to hammer out a deal, though you might have to pay a large lump sum or a few monthly payments. The best part about talking with your creditor: it’s free.
If your debt issues are truly out of control and affecting your quality of life, you might consider filing for bankruptcy as a last resort option for getting out of debt. While filing for bankruptcy will have long-term financial consequences, it might be necessary if you’re in a dire situation with no alternatives. You should talk with a financial advisor or bankruptcy attorney before deciding to file for Chapter 11. You have to get credit counseling from a government-approved organization within six months before you file for any bankruptcy relief.
Whatever method you choose to get rid of your debt, you must have a plan of action. Debt is a silent killer that will harm your financial life if you don’t learn to manage it effectively. If you need help calculating how much you’ll have to pay every month to eliminate your debt, use an APR Loan Calculator. It might be a slow and painful process to become debt free, but the longer you wait, the more difficult it will be.
Daryl is a staff writer at MyBankTracker.com who specializes in consumer spending, student finances and debt.