Avoid Debt Settlement Companies: the Cons Far Outweigh the Pros
We have all heard debt settlement companies advertise on television, and they all promise the same thing: to settle your debt for pennies on the dollar. And for a lot of people, this sounds like a great deal. After all, most people want to avoid filing for bankruptcy. They think they are a failure if they file for bankruptcy. And signing up with a debt settlement company appears to be the best chance they have to avoid “failure”. But don’t let the ads fool you. Signing up with a debt settlement company is a bad idea.
How Debt Settlement Companies Operate
First, you need to understand how a debt settlement company operates. It advises you to stop paying your bills and stockpile your cash until you have enough to start making lump sum payments to your creditors. In essence, you go into default and stop all communications with your creditors until you save enough money to start making offers to your creditors. There are several problems with this approach, but the three most glaring are: (1) debt settlement companies charge thousands of dollars in fees, (2) the plan hinges on you going into default on your loans, and (3) it kills your credit score.
Debt Settlement Companies Charge High Fees
Debt settlement companies charge outrageous fees. If you compare what a bankruptcy attorney charges to what a debt settlement company charges, the debt settlement company will almost always be more expensive. Typically, your fee will be several thousand dollars. To make matters worse, these companies will not negotiate with your creditors until they are paid in full. In other words, for the first six months to a year, your monthly payments go directly to the debt settlement company and not your creditors. And forget about the debt settlement company negotiating anything on your behalf until they are paid in full.
Do Debt Settlement Companies Actually Negotiate?
So how do these debt settlement companies negotiate with your creditors to reduce your balance? By the time the debt settlement company negotiates with your creditors, you will be in default for a long period of time. In most cases, your debt has been written off by the time the debt settlement company negotiates with your creditors. The debt settlement company makes an offer for about half of what you owe. The debt settlement company will argue that collecting 50% on a non-performing loan is better than nothing. And in some cases, the creditor will accept the offer.
Things Can Always Get Worse
But as times get worse, most creditors are not sitting on their hands for a year or two hoping that you will make an offer. As cash gets in shorter supply, your creditors are getting more aggressive with their collection efforts. Debt settlement companies exacerbate this by instructing you not to have any interaction with your creditors. The rationale is that it will induce your creditor into accepting a low offer. In reality, it leads to a lot of people having their wages garnished.
Lawsuits are Still Possible
If one of your creditors sue you, you are on your own. Every debt settlement contract I have ever read–and I have read a lot–all stipulate that they will not represent you if you are sued for being in default. Before the recession, this was not as big of an issue because creditors were not as aggressive with their collection efforts. But times have changed, and collection efforts have really ramped up. When you are in default, you run a serious risk of being taken to court and having your wages garnished. If this happens, don’t expect the debt settlement company to do a thing to help you.
If you are lucky enough not to be hailed into court, then you still have several road blocks in front of you. First, your creditor is not obligated to accept your offer. They can reject your offer and take you to court, or continue to try and collect the full amount you owe. Second, if your creditor accepts your offer, then by definition they have forgiven part of your debt. In a lot of cases, you need to pay taxes on the forgiven debt. Compare this to bankruptcy where there are no negative tax implications when your debt is discharged.
Also, do not think you will be saving your credit score by going the debt settlement route. In fact, if you go this route your credit will be significantly harmed. Your credit history will reflect all of your late payments and that will reduce your credit score. Don’t avoid bankruptcy and sign up with a debt settlement firm hoping to save your credit.
You Can Do it Yourself
Finally, why pay a debt settlement company to negotiate with your creditors? There is absolutely nothing stopping you from offering to settle your debt for a smaller lump sum payment. Debt settlement companies might pretend to be experts, but in reality, all they are doing is calling and making the same offer you can make. If you are up for a little haggling, there is no reason you can’t do this yourself.
If you are already sideways with a debt settlement company, you have several options. Debt settlement is illegal in several states. Call your attorney general and see if anyone can help. In some states, like Kansas, you have a private right of action against debt settlement companies. So if you have paid these companies thousands of dollars, all is not lost. There is hope that you can get your money back. Contact a bankruptcy attorney, or your state’s attorney general, and see if you have any way to try and get your money back.