Have a big liability that’s legitimately yours but can’t or don’t want to repay it in full? You may be able to avoid covering some of what you owe – or even most – with a debt settlement. Or not. After all, the creditor – not you – decides on if it will give you a break. In general, it’s unlikely that you’ll be able to reduce the amount of a current credit card bill, but if you’ve already missed a few cycles or it’s been sold to a third-party collector, your chances of getting a break increase.
As a consumer, you have the right to ask any creditor if they’re willing to accept a smaller sum, with the contingency that they will not come after you for the difference. When settlements are properly arranged, you’ll have the pleasure of going to bed at night knowing that in the morning you’ll wake to no more demanding phone calls or letters.
However, doing it yourself requires extensive communication, bargaining, letter writing, and standing in line at the post office to send correspondence via certified mail. Once done you’ll have to follow up to make sure all is as it should be. It’s a rigorous and not particularly pleasant process. Worse, success is not guaranteed. Did you get the best possible deal? What happens if the creditor doesn’t honor the agreement and hunts you down for the remainder?
Because of these questions, working with a debt settlement company can be attractive. By doing so, you’ll put the case in their (hopefully) capable hands. All you have to do is wait to see what they come up with. And pay the price, of course. Here are six key points to know about debt settlement companies.
- Know how they function. The fact is, a debt settlement company can only do what you can do for free – but for a fee. Any company that claims social powers is not being truthful. If your bill is still with the original creditor (such as your credit card issuer or a department store) you’ll be asked to cease payments and send the money to them instead. If the debt is with a credit card issuer, late fees and interest will accumulate. The settlement company will keep the funds in a separate account until you’ve racked up enough for the company to offer a fraction of the balance as a lump-sum settlement. Some lawyers settle accounts, too, and if they don’t use this system, they’ll typically charge by the hour.
- Quality varies. Just as you wouldn’t dine at a restaurant that’s been cited with serious health code violations, you shouldn’t hire a debt settlement company with rotten reviews. Yet countless desperate debtors do no more research than choosing the first that pops up in an internet search, or call the one advertised on television. Do not do this! Some are definitely better than others, so check their rating on the Better Business Bureau’s website or type the company name then “review” in the online search bar. Read as many real-life accounts as possible, focusing on the latest updates, before deciding.
- Beware of lawsuits. It’s important to know that if you do stop paying your bills as instructed, the creditor may decide to take legal action against you. That you’ve hired a debt settlement company is irrelevant. They’re not getting paid and they want the money. So be on the look out for a summons to appear in court. If you are sued, you’ll probably lose the case and that could result in an even higher debt since the balance will be bloated with attorney and court costs. If you’re working, the judge may permit the creditor to collect with a wage garnishment.
- Figure out the fees. Federal law prohibits debt settlement companies from charging upfront fees – so if they ask for it, run fast. What they can do is charge you a percentage of either the total amount of the debt they’re handing or the amount they saved you with the settlement. Clearly the financially superior plan is to parter with a company that will take a cut of the savings. For example, 25 percent of a $5,000 debt is $1,250. But if the company got the creditor to settle for $2,000 and charged 25 percent of the savings ($3,000) the fee would be a far lower $750. Mind that fees vary by state law, and in some states they are capped at lower rates, such as 15 percent.
- Understand the credit reporting damages and advantages. If you’ve been making timely payments and then go delinquent, your credit rating will take a nosedive. But if the account is already behind, in default, or in collections, the impact of the settlement will be less severe. On the upside, a satisfied debt can help with credit utilization, because it will bring your overall debt down. Still, many creditors will notate the account as settled rather than paid in full. That doesn’t affect a credit score, but if a lender, landlord, or employer looks at your actual reports and sees the notation, they may form a poor opinion of you. It’s a clear indication that you did not fulfill the original obligation.
- And speaking of taxes…This is very important. If you are relieved of paying a portion of the debt with a settlement, it could trigger a taxable event. After the deal is complete, you might receive a tax form 1099C, or a “cancellation of debt.” That means you could be liable for taxes based the forgiven amount, which might represent a considerable tax obligation, especially if the creditor forgave a large amount.
So should you use a debt settlement company? That depends. If you have the opportunity and energy to arrange your own settlement, do it. If you’re a busy parent, work a couple of jobs, travel lot, or are just flummoxed with the entire process, hiring a company to do the work for you might be the way to go. It’s no more strange than hiring a professional to paint your house or prepare your taxes and it could save you hundreds or even thousands of dollars. But if you have the money to pay, either over time or all at once, you should.