Debt Settlement Companies-Beware!!! I meet with many people who fall victim to the debt settlement company scam. For those of you who aren’t that familiar with what debt settlement companies do, I’ll explain, but I think it’s helpful to have some background first.

Dealing with debt and creditors is a very stressful process. People who have too much debt often feel as if they have no options. Creditors are very difficult to deal with, and debt is scary. Debt settlement companies, and other companies like them (to be addressed in future posts), prey on that stress and fear and offer a “seems too good to be true” solution to dealing with that debt.  Well, folks, the old adage holds true -when something seems too good to be true, it usually is. In this case, it definitely is.

Debt settlement companies, sometimes posing as law firms, or actual law firms, offer to help someone settle their debt, i.e. pay to their creditors a total of much less than what’s owed, in exchange for a hefty fee. Usually, these companies will promise to settle debt for approximately 60% of the total balance owed, i.e. if someone owes $5,000 on a credit card, the debt settlement company will get that credit card company to agree to take $3,000 as payment in full on the account, instead of $5,000.  Sounds good, right? Wrong.

The  debt settlement company will then offer the customer a payment plan on that $3,000. The customer makes monthly payments to the debt settlement company, the company then takes their fee and puts the remaining payment into a savings account until $3,000 has been saved to make the settlement offer to the credit card company. The debt settlement company offers a 4 or 5 year payment plan to the customer to save that $3,000. Sounds even better, right? Wrong. I can’t begin to give all the details of why it’s wrong, but I’ll touch on the most important ones here:

1) If a creditor agrees to settle, like in the example above, for 60% 0f the balance, by the time the $3,000 is saved up over 4 or 5 years, the balance on the credit card will be substantially higher than $5,000, and therefore $3,000 is no longer 60% of the current balance. The customer is caught in a never-ending cycle of failure.

2) Creditors won’t wait 4 or 5 years for their money, unless they are receiving the money through a Ch. 13 bankruptcy and are therefore forced to wait by law.  If no bankruptcy is involved, creditors will most likely sue customers much earlier than 4 or 5 years down the line, and then collect on the judgments they get, putting customers at risk of wage-garnishment, loss of property, etc. Judgments are scary. Customers need to avoid them, and debt settlement companies, regardless of their promises DO NOT help customers avoid judgments. A judgment is a court order that states the customer owes a certain amount of money to the creditor. If that’s true and the money is owed, how is the debt settlement company going to help the customer get out of that one? They’re not. Point made.

3) Creditors hate debt settlement companies and often have internal policies forbidding account agents to work with them. Creditors would much rather deal with the individual customer directly than with a third party. The lesson learned here? Don’t try to browbeat a creditor into accepting a settlement or payment plan. It won’t work.

4) Creditors normally won’t settle a debt for less than the full amount owed unless a customer can make the payment (i.e. $3,000 in the example above) for the settled amount within 30 days from settlement. Certain accounting rules the creditors have to follow require this. Funny how the debt settlement company doesn’t mention this, huh?

5) Settling a debt for less than the full amount owed can have serious tax consequences for a customer. When someone settles a debt, the creditor is required by the IRS to send the customer a 1099 for the amount the customer didn’t pay (in the example above, the remaining 40% of the balance). This amount is considered taxable income to the customer. Again, debt settlement companies don’t tend to mention this.

6) Debt settlement companies charge ridiculous fees for their services, essentially, for something a customer could do him/herself . Further, the companies take their fees before allowing a customer to save for settlement, so often a customer has been making monthly payments for 6 or 7 months to a debt settlement company, and all that money has gone toward the company’s fees, and none is saved to give to the creditors. This practice has the FTC watching these companies closely and closing them down when appropriate.

Overall, again, dealing with debt can be a very stressful matter, but consumer shouldn’t dig themselves into a deeper hole than where they started. If you find yourself dealing with too much debt, contact a licensed attorney in your area or other financial professional who gan give you the information and guidance you need. Debt settlement (and bankruptcy) can be a very helpful and useful solution when done with care and full knowledge of the process. Not all debt settlement companies are scams, but be very careful.  Take control of your debt, don’t fall victim to it!