Settle your debt for pennies on the dollar without filing bankruptcy – this is a typical catchphrase debt settlement companies use. Sounds great but beware of the process and the uncertainties that it brings.
Debt settlement is typically done through a debt settlement company. That company negotiates your debts with credit cards and other creditors with the hope that those credit cards will take a lesser amount of money (or at a lower interest rate) than you are paying now. There is no guarantee if any or all of your creditors will actually settle.
Creditors are not legally required to work with you or the debt settlement company.
Debt settlement is usually limited to unsecured credit cards and personal loans. It WILL NOT work with ongoing car payments, ongoing house payments, and garnishments.
Unless you have cash on hand (and let’s be realistic here most people do not) you will be required to make monthly payments to the debt settlement company.
That debt settlement company will likely put all the funds into an escrow type account. They will almost always pay themselves first. When or if the debts are settled the company will use the money collected to actually pay your debt. You may have to pay fees to the escrow account company (these are often hidden fees).
Depending on the amount of debt you have you can be making monthly payments into the escrow account for a few years without actually having settled a single account with any of your creditors. The debt settlement company is relying on your creditors to sell your debts to other companies and then settle them.
Once you have enough money accumulated in the account the debt settlement company will begin negotiating on your behalf.
If the debt settlement company goes out of business or if they are unable to settle your claims there is no guarantee that you will get your money back. There is no direct oversight by the Court.
You will pay fees upwards of $3,000 to a debt settlement program with a high rate of failure for their services. There are no guarantees and no oversight for their services.
You will also pay an undetermined portion of your actual debts, assuming the company’s ability to actually settle your debts and the willingness of your creditors to work with them (and you).
Debt settlement by itself does not prevent collection calls. Debt settlement companies rely on you to send letters to your creditors under another set of federal laws to stop the phone calls.
The success rate of debt settlement programs is very low in terms of the total settlement of someone’s debts. An individual may get 4 out of 10 debts settled, but by the time that is done the other 6 debts will have ballooned out of control due to increased interest rates, late fees, and penalties. The savings from settling some of the claims is then wiped out and you are often facing lawsuits.
Your credit report will most likely suffer due to late payments and possibly reports of write-offs. This type of reporting goes on monthly until the debt is settled or until it lapses off of your report (7 years in most cases from the time of default).
The constant month to month negative reporting often has a greater long term negative effect than a bankruptcy by itself.
Even when debts are settled, they often report as paid in less than full.
There are serious consequences if you stop communicating with your creditors directly and instead rely on non-attorney representatives – such as getting judgements against you.
If you get sued during a debt settlement program you will soon discover that you do not have an attorney. They may guide you to file documents on your own in the lawsuit, but they do not appear or argue for you.
Tax consequences – creditors will issue a 1099 for the amount of debt that was forgiven. You may have to pay taxes on that amount. This means that if you settle your $50,000 of credit cards for $20,000 you will get to pay taxes on $30,000 of income.