As millions of Americans struggle to pay down debt, many are lured in by debt settlement companies' promises to slash debt in half--or more.
The basic pitch goes something like this: "You pay an upfront fee (typically 15% of the pre-settlement balances) and we tell your creditors to talk with us and not contact you. Then you send us a monthly payment, which we'll store until you are ready to settle. When you are ready, we will negotiate a settlement with your creditors--many are willing to settle for 50 cents on the dollar. You'll wind up debt-free, with a solid credit rating."
Attractive as the promises may seem, there are catches:
- Creditors don't see any payments until you decide to settle, so they may get increasingly frantic. That raises the possibility of more late fees and higher interest rates. The creditor even may send the debt to a collection agency. But you won't know about that because the communications will be going to the debt-settlement firm, not to you, says Kenneth King, executive director of Consumer Credit Counseling in Sheboygan, Wis.
- Some creditors may start a lawsuit due to nonpayment, especially if the debt is large. Debt settlement companies do not protect against legal action.
- Few creditors are willing to settle for such chump change.
- If they are, you can negotiate this settlement yourself, without paying the settlement company.
- If the debt does get settled at a discount, your credit rating will reflect your partial payment--and,
- You will owe income taxes on the discount.
The Better Business Bureau (BBB) says to watch out for these red flags:
- Hefty upfront fees
- Unrealistic promises to erase debt
- Orders to stop contact with creditors, and false claims that the organization is a nonprofit (you can verify a company's claims with the BBB). The BBB recommends getting advice from friends, family members, and people in your community to be sure a company is legitimate.
Instead of turning to a debt settlement company, you might first consider turning to your local trusted credit union or financial institution for help.
Read the full Home & Family Finance article here