Debt settlement companies can be a lifesaver for people facing overwhelming debt. According to a 2015 study by the American Fair Credit Council, over 90% of consumers who enter a debt settlement program resolve at least one account within the first 8 months. The average settlement amount of an account enrolled in a debt settlement program is nearly half (48%) the initial balance (source).
That doesn’t mean you shouldn’t be cautious when selecting a debt settlement company. If you take the time to research a restaurant on Yelp, you should certainly do your homework before dealing with a debt settlement firm. SuperMoney provides free expert and consumer reviews, so you can check out companies before committing to one of their debt relief programs.
This article will help you become a savvy consumer by considering eight issues many debt settlement companies won’t tell their customers. Next time you consult a debt settlement company, ask about these issues. Keep away from companies who try to minimize the risks and overstate the benefits of negotiating a debt settlement.
Debt settlements require patience and grit
As helpful as debt settlement programs can be, they are not for the faint of heart. True. More than half the consumers who enroll in debt settlement programs start to settle accounts within the first four months. However, it usually takes 24 to 48 months to settle all their accounts.
Debt settlement firms can help you to screen the calls and harassment of debt collection agencies. But they cannot promise they to block every nasty call from a debt collector.
There are other debt relief services available
Credit counseling can be an effective choice for debt balances of less than $10,000. When done correctly it can consolidate your debts into a single payment while reducing interest rates. However, this method will not reduce your overall debt and it’s not a viable option for debtors who can only afford to make minimum payments on their existing debts. Another concern is that counseling programs have high dropout rates and can take 7 years or more to complete.
Filing bankruptcy can reduce your debt balance, particularly if you qualify for a Chapter 7 bankruptcy. However, the bankruptcy reforms of 2005 have made much more difficult to qualify. Chapter 13 bankruptcies are easier to qualify for and provide protection from the harassment of creditors. On the other hand, they stay on your credit report for up to 10 years and still require you to repay a percentage of your debt.
The IRS can tax your debt settlement
Yes, it may sound crazy, but the IRS may tax you for the debt reduction you receive in a debt settlement. You see, when creditors agree to a debt settlement they report the money they forgive as a business loss to the IRS and claim a tax deduction. The IRS considers the forgiven debt as taxable income and bills the debtor. The good news is there are exceptions to this debt as income rule. Read this article to find out whether your situation qualifies as an exception.
Your credit score will drop
It is next to impossible to negotiate a debt settlement without hurting your credit score. You see, for a debt settlement program to work you have to convince creditors that you can’t afford to pay your debt in full. In most cases, the only way to do that is to stop making payments. Another reason to stop making payments is that for most consumers it’s the only way they can save money toward a future lump sum settlement. Creditors typically report the missed payments to credit reporting agencies, which obviously damages their credit score. Reputable debt settlement companies always make it clear your credit score will take a hit when you enroll in a debt settlement program.
Business is booming for debt settlement companies
Debt settlement programs provide a valuable service to consumers who seek relief from overwhelming debt. Unfortunately, overwhelming debt is becoming the norm in the United States. If you are struggling to make minimum payments on your loans and credit cards, you are not alone. Not by a long shot.
Credit card debt alone is set to hit $1 trillion by the end of 2016 and the average household with credit card debt owes $16k. What is even more worrying is that 47% of Americans don’t have the cash to pay for a $400 emergency (source). This means debt settlement companies are not going to run out of clients any time soon.
It is possible to negotiate a debt settlement by yourself
There is nothing stopping you from negotiating directly with your creditors. Just like you can try to work on your own car or self-diagnose your symptoms instead of paying a mechanic or visiting a hospital. If you only have a couple of small loans that amount to $5,000 or less, it might make sense for you to talk directly to your creditors. This article provides some tips on how to negotiate directly with creditors.
Having said that, if you have multiple accounts or you owe more than $5,000, you will probably benefit from the assistance and guidance of a professional debt settlement firm.
Creditors are not required to agree to a settlement
There is no law that requires creditors to accept a settlement or even to enter into negotiations. That’s one reason why negotiating directly with creditors is so difficult. Creditors will do everything they can to get you to pay your debt in full. Experienced debt settlement companies understand the debt settlement policies of major creditors. They also know how to deal with their stalling tactics. Sure. There are fees to pay. But you have a much better chance of success when you use a professional debt settlement firm. According to a survey of over 1.9 million consumer accounts, debt settlement firms save customers between $2.75 and $3.13 for every dollar $1 they pay in fees (source). Still, there is no guarantee your creditor will accept.
There are professional associations that regulate the debt settlement industry
As with other professions, reputable companies in the debt settlement sector are members of trade associations. The largest debt settlement trade association is the American Fair Credit Council. The AFCC acts as an industry watchdog to protect the interests of consumers. Members agree to follow the strict standards and best practices set out by the AFCC. Think twice before hiring a debt settlement firm that is not willing to comply with industry best practices.
The Federal Reserve recommends consumers who are struggling with significant credit card debt to contact a debt relief service if they can’t work out a repayment plan with creditors on their own (source).
Debt settlement firms can be a powerful debt relief tool. However, not all debt settlements are made equal. Depending on your financial circumstances and goals, there might be better debt relief options. Click here to get a free debt settlement consultation with a SuperMoney approved debt settlement firm.
We partner with companies that:
- Have a successful track record.
- Employ debt specialists that are certified by the International Association of Professional Debt Arbitrators.
- Are members of the American Fair Credit Council.
Join the thousands of people we’ve helped to settle almost $5 billion of debt. Find out for free whether you are a good candidate for a debt settlement program.
Andrew is the managing editor for SuperMoney and a certified personal finance counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.