CreditCardGuru

You see the ads everywhere… magazines, newspapers, spam in your inbox, and you hear these “non-profit companies” advertised on the radio and TV too. I’m talking about debt consolidation groups. If you’re up to your eyeballs in credit card debt, they promise to settle it for “pennies on the dollar” within 6 to 8 months. Sounds like a good deal, huh? Well before you call them up… read how it really works right here.

Many of these debt settlement companies operate under the disguise as a “non-profit” consumer advocacy group for tax reasons, but don’t think for a minute they’re doing any charity work. What they sell you (yes, you pay them a lot, too) is a program which requires you to deposit a lump sum or money into a savings account. Or if you don’t have a lump sum, you are required to setup automatic monthly deposits into this account. Once this savings account has a certain amount of funds in it, the debt settlement “non-profit” will call up one (just ONE) of your creditors and offer to make a settlement for a lump-sum payment.

Do you get to settle your debts for less? In theory only – the answer is “yes” it may possibly work. But let’s break down the pros and cons of this so I can show you why it probably never makes sense to do it. You’re going to run into some major problems with these programs:

First off, you’re ordered to stop paying all your bill immediately. Think your credit isn’t good? Watch it really take a nose dive now! Not only will what’s left of your credit go out the window, but you’ll be getting some of those friendly calls from debt collections and creditors. You say you already get those? Well this “debt settlement” won’t help you with that either, as the process takes several months.

Second of all, those mandatory monthly deposits to the savings account are skimmed off for fees by the debt settlement company. These are usually 15 to 20% of the debt you owe. Yes that’s right, not 15 to 20% of the amount they settle for, but 15 to 20% of the value of all your debts. So right off the bat you’re already paying up to 20% or more for this service. All the meanwhile, since you’re ordered to stop paying on the debts, those debts just keep increasing with more interest, late fees, non-payment fees, and whatever other fees they can tack on now. So they put you in more debt so you can pay them a higher commission! They don’t try and settle on the debt until there’s a big boat load of money in this savings account… so you may go through this for months and months!

Third, time is against you here. Let’s say you jump through their hoops and save up enough to settle that first debt. That’s only the first debt. Next you have to do the second, the third, and so forth. Your creditors aren’t just going to sit around so you can not pay a dime and then make an offer later. Your accounts are 30, 60, 90 day late, sent to third-party debt collectors, charged off, sent to attorneys to go after you, and all that other bad stuff.

Fourth, and probably the stupidest part of it all, is these debt settlement groups make you a target! Often they tell your credit card companies and other creditors that you’re doing a debt settlement plan. They ask the creditors to sit by and wait since an offer will be coming. Oh they’re a smart cookie, let’s see… you haven’t been paying on your bills and the debt settlement companies tell your creditors your saving up tons of cash in an account somewhere to pay them off later? The second they know about that money they can have a court order issued to have it forked over to them immediately! And NOT for a reduced amount, that money will just be applied to whatever amount you owe – which has now grown with more interest and late fees! Also they're saying you have extra-income to stash away in a savings account, yet you can’t pay anything on your bills? Well say hello to court ordered wage garnishment! This is a total losing situation for you. Do you think the debt settlement company gives a crap? Not at all – they’re still making their same fat 15 to 20% commissions on that money you’ve been depositing into the savings account.

So let’s say your debt settlement is a “success” and they settle your debts for less than the principle. This is what you’ll get… a credit report that’s shot and maybe they were able to settle one or two of your debts. These will show up on your credit bureau reports as “settled for less than full” which is another huge hit too. Oh and for that amount they were able to shave off your debt? Guess what… the IRS views that as straight up income, so now you have to pay taxes on it! If you think that’s bad it gets worse… you’ll also be left with a boatloads of judgments and likely court-ordered wage garnishments for those other debts you defaulted on too!

How much did they save you? Well let’s say they were able to settle your debt for 50%... and that would be in a good scenario, they probably settled it for 60 or 70%. Then on top of that they took 15 to 20% off in fees. 50% plus 20% = 70 cents on the dollar. For all that they saved you a whopping 30%! Wait, actually they didn’t… you see the settlement amounts includes the new late fees and interest (and interest hikes) they caused, so you’re debt may be 30% more than when the process started anyway. At the end of the day the only winner is the debt settlement company.

If you need this service, it’s unlikely you can afford it in the first place. Let’s say you have $10,000 in debt they are able to settle for a 50% discount after half a year. During that time you will be required to deposit $833 per month into that special savings account they set up. If you can’t afford the minimum monthly payments on your bills, how can you afford an extra $833 per month?

If this was a solution that worked, trust me I’d recommend it in a heartbeat. But as you can see there’s no way the consumer can come out ahead with this shady system. What is your best bet? Here’s three steps to pay off your debt cheaply and save your credit record:

Step One: Make the minimum monthly payments, on time, on all your accounts.

Step Two: Consolidate your debts into credit cards with the lowest intro rates. (you’ll find some great offers on this forum). Did you know most credit cards allow you to consolidate all kinds of debts, not just other credit cards? So do that and lock it in using 0% intro APR credit cards or the lowest APR you can get. If you’re paying 15% to 25% or more in interest per month, most of your minimum monthly payment is probably going towards the interest and not the amount you owe. Imagine if that was consolidated to lower rates? You could be paying the exact same amount per month, yet paying off your debt much faster.

Step Three: Continue making your payments on time, every time. Pay more than the minimum whenever possible. Keep that up and you’re on the way to being debt-free. All the meanwhile you’ve done it the right way and kept your credit intact.

jhudson

I don't even understand how these so called debt settlement companies are even legal?! They harm more than help. Someone needs to take action against these scam artists and make it illegal.

Floppster

I presume that many things will change due to the current situation. The cash paying society will come back more and more. Less and less Credit Card will be issued and these Debt Settlement rip offs will be history as well.

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Mogul of Pineapples

I agree. Credit cards will probably no longer be handed out like candy at Halloween. Lower credit limits should be expected too. As a result from this the debt settlement scams should start to become rare because Americans will no longer have the ability to dig themselves so deep into debt like they could in the past.

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