If you’re burdened with overwhelming financial obligations, you may be tempted to turn to a debt settlement company for relief. A debt settlement is when a creditor agrees to accept less than the total amount owed. Companies that arrange settlements promote their services as a cost-effective alternative to dealing with the debt on your own, and as superior to a repayment plan that a credit counseling agency may arrange. Unfortunately, most of the time using such a business only leads to greater problems.
How debt settlement companies work
A debt settlement company requires you to stop making payments to your creditors and deposit a specific amount of money on a monthly basis into a specially designated savings account (sometimes called a “trust” account) instead. Once you have built-up a certain amount of cash, the company will offer a lump-sum payment to one of your creditors. After one account is settled, they will do the same with the next and so forth until all accounts are paid.
What they promise
Most debt settlement companies promise basically the same things – among their claims:
- They have privileged and established relationships with creditors and so can get a better settlement than you can.
- By enrolling in their service, your financial troubles will be over in a very short time (typically six to eight months).
- Settling your debts won’t harm your credit report and may even improve it.
- If you work with them, your creditors are prevented from suing you for non-payment.
- While these businesses may indeed be able to reduce your overall debt load, the other claims are misleading or false.
Problems with debt settlement companies
In truth, debt settlement companies don’t have special creditor associations, and the deals they arrange are no better than what you would be able to negotiate. Other problems include:
- Not all of the money that you are depositing into this special account is going toward the lump sum payment. Some of it is going toward the company’s fees, which are typically between 15 and 20 percent of the debt.
- Credit report damage.Because the company advises you to stop making payments, issuers for any current accounts will report the missed payments to the credit bureaus. The more months you don’t pay, the worse the credit damage becomes, especially when the creditor charges the debt off and sends it to a third-party collector. Even if the company you are working with settles an account, the affect on your credit report will be negative. The notation will be “settled for less than the full balance” which is less desirable than “paid in full.”
- Collection activity.If you suddenly stop paying your accounts, be prepared to get some pretty aggressive phone calls and letters from your creditors demanding payment. Dealing with collectors is typically very unpleasant.
- Bigger, more problematic debt.During the time you are not paying, any account that accumulates interest and fees will grow. The more time you wait, the more money you’ll need to settle the account. Also, by this time, any account that is not with a collection agency will be with – or the creditor will transfer it to – their legal department.
- Some debt settlement companies say that they can prevent legal action and even quote laws that back their claim up. This is false. If you do not pay your debt as agreed, any creditor has the right to take you to court. In fact, yet another problem with using a debt settlement company is that it could trigger a lawsuit rather than avert one. This is because the company will contact your creditors and tell them that you are using their services. Your creditors will know that you have at least some cash that they can sue you for. Without question, getting sued for a debt is something you really want to avoid. The debt will be larger than it was before because court and attorneys costs will be added to the balance, and the creditor may be able to garnish your wages and claim funds from your accounts.
- Some debt settlement companies are pure scams – they will take your money and then disappear. This will leave you with deeply damaged credit, possible lawsuits, and a lot less money than you used to have.
You do not have to pay a company to settle your debts. If the creditor is willing to negotiate, you can do it yourself for free. Also, if you have enough cash to put into a debt settlement account, you could have enough to make minimum payments to your creditors. Develop a spending plan to know and refine your cash flow. By increasing your income or trimming your expenses, you may be able to pay as agreed – and really improve your financial situation.
Another option is a Debt Management Plan. Hanscom Federal Credit Union partners with BALANCE coaches, financial professionals who can review your entire financial situation and help you make a plan to get out of debt.