What is debt settlement?
Debt settlement programs are different from debt management plans. Debt settlement programs are typically offered by for-profit companies to people with significant credit card debt. The companies negotiate with your creditors to let you pay a “settlement,” or lump sum of money that’s less than what you owe. They agree that this amount will settle your debt. Meanwhile, you have to set aside a specific amount of money every month in a designated account until you have enough savings to pay off any settlement that’s reached. These programs often encourage you to stop making any monthly payments to your creditors.
Debt settlement programs can be risky. If a company can’t get your creditors to agree to settle your debts, you could owe even more money in the end in late fees and interest. Even if a debt settlement company does get your creditors to agree, you still have to be able to make payments long enough to get them settled. You also have to watch out for dishonest debt settlement companies that make promises they can’t keep, charge you a lot of money, and then do little or nothing to help you. You may not be able to settle all your debts. While you’re in the debt settlement program you may still get calls from debt collectors and your credit report and credit score are likely to be damaged. The process can take years to complete.
If you do business with a debt settlement company, you may have to put money in a special bank account managed by an independent third party. The money is yours, as is the interest the account earns.
The account manager
may charge you a reasonable fee to manage the account
must transfer money from your account to pay your creditors and the debt settlement company when settlements happen
What does a debt settlement company have to tell me upfront?
If you decide to go forward, even after reviewing the risks, there’s more to know. Before you sign up for its services, the company must tell you
the fees, any conditions, and terms of service
how long it will take to get results: how many months or years before it will make an offer to each creditor for a settlement
the possible negative consequences of stopping payments to your creditors (if the program relies on you doing that).
how much you must save in a dedicated account before the company will make an offer to each creditor on your behalf
The debt settlement company cannot collect its fees from you before they settle your debt. Generally, there are two different types of fee arrangements (a proportion of the amount of debt resolved or a percentage of the amount saved). Each time the debt settlement company successfully settles a debt with one of your creditors, the company can charge you only a portion of its full fee.
The debt settlement company also must tell you that
the funds are yours and you are entitled to the interest earned;
the account administrator is not affiliated with the debt settlement provider and doesn’t get referral fees
you may withdraw your money any time without penalty
What are the risks of debt settlement?
There might be a negative impact on your credit report and credit score. Debt settlement programs often ask — or encourage — you to stop sending payments directly to your creditors. That means late fees and penalties may grow, put you further in the hole, and hurt your credit.
Creditors might start debt collection. While you’re in the debt settlement program you may still get calls from debt collectors requesting repayment. You could even be sued for repayment. If the company wins, it might be able to garnish your wages or put a lien on your home.
You might not be able to settle all your debts. Your creditors have no obligation to agree to negotiate a settlement of the amount you owe. Debt settlement companies also often try to negotiate smaller debts first, leaving interest and fees on large debts to grow.
You might not finish the whole program. Many people have trouble making payments long enough to get all — or even some — of their debts settled. They drop out of the programs as a result. If that happens, you’re out the fees you paid the debt settlement company for any debts they’ve already settled, you will still owe any debts that haven’t been settled yet, and your credit report probably shows late payments which can hurt your credit. Before you sign up, review your budget carefully to make sure you’ll be able to set aside the required monthly amount for the whole time.
There could be tax consequences. Any savings you get from debt relief services could be considered income and taxable. Talk to a tax professional to learn how this might affect your situation.
What are some signs I’m dealing with a debt settlement scam?
Spot and avoid scammy debt settlement or debt relief organizations — whether they’re offering credit counseling, debt settlement, or any other service.
Never pay any group that tries to collect fees from you before it settles any of your debts or enters you into a debt management plan.
No legitimate organization will guarantee to settle all of your debts or get you fast loan forgiveness.
No legitimate organization tries to enroll you in its program without first reviewing your financial situation.
No legitimate organization will guarantee you results from a “new government program.”
No legitimate organization tells you to stop communicating with your creditors without explaining the serious consequences.
No legitimate organization tells you it can stop all debt collection calls and lawsuits.
To learn more about the companies you’re considering, search online for the company’s name, plus “complaint” or “review.” Read what others have said. Also check out any company you’re considering with your state attorney general and local consumer protection agency.
Can I work out a solution to eliminate my debt on my own?
Instead of paying a company to talk to creditors on your behalf, you can try to settle your debt yourself. If your debts are overdue the creditor may be willing to negotiate with you. They might even agree to accept less than what you owe. Sometimes it’s possible to work out an agreement so your debt is eliminated and debt collectors can’t sue you for the debt. If you do reach an agreement, ask the creditor to send it to you in writing. And just like with a debt settlement company, if your agreement means late payments or settling for less than you owe, it could negatively impact your credit report and credit score.
