If you are deep in debt and don’t see how you can ever climb out of it, you can get desperate. Now suppose you see a TV ad or get mail from a company that promises to reduce your debt to a fraction of what you owe, maybe even make it disappear completely. Tempting? Just remember, if it sounds too good to be true, it often is. With the average credit card debt on the rise again, its no wonder people are looking for debt settlement options.
The Promise of Debt Settlement Companies
Debt settlement can be a viable option and a last-ditch alternative to bankruptcy, but it can also be a scam. Debt settlement companies are much more regulated than they were at one time, but there are still risks. The promise is that the debt settlement company will negotiate with your creditors to accept an amount less than what you owe, usually in a lump sum. Often this involves credit card debt. Be aware that debt settlement companies cannot help you with debts that involve collateral such as car loans or mortgages. They also cannot help you with federal student loans.
The Downsides of Using a Debt Settlement Company
Debt Settlement Usually Takes Years
If you enter a debt settlement company program, it can take three or four years or even longer to settle. Debt settlement company customers are usually instructed to stop paying their debts and instead put the money into a savings account. You own the account and make monthly deposits of an amount agreed to with the debt settlement company. Since you are no longer paying your creditors, you become delinquent and your credit score drops significantly. Accounts that are delinquent and charged-off by creditors stay in your credit history for seven years. Your creditors could also sue you.
You Will Pay Typically 20-25% For The Service
The way it works with debt settlement companies is when you have deposited enough money into the savings account, the company will start talking with your creditors. Since they have not been paid anything for some time, the hope is they will be softened up enough to accept less than the full amount owed. If a settlement is reached, you pay in a lump sum or agreed upon installments. You then also pay the debt settlement company, typically from 20% to 25% of enrolled debt. Debt settlement companies are now forbidden by the FTC from charging upfront fees due to prior abuses.
Debt Settlement Companies Avoid Laws By Using Attorneys
However, there are debt settlement companies that still get away with charging advance fees by setting up a loose partnership with an attorney. This way, attorney fees can be used to justify getting some payment in advance. The FTC rule does not cover in-person meetings, so the debtor is directed to first speak with a local, affiliated attorney. The reality is that the attorney does not do any work to settle your debt. That is passed on to others in the company. Don’t be fooled by this ploy. It’s just a way to get your money when there is no guarantee of success, and if the company is successful, it will likely not be for years.
Debt Settlement Company Programs Are Often Unsuccessful
The Center for Responsible Lending reports that a substantial share of consumers are unlikely to settle enough debts to benefit from a debt settlement program. Some creditors will not even negotiate with debt settlement companies, though the debt settlement companies may not tell you that. A 2012 survey of credit card issuers, debt buyers, and debt collectors showed that only half of those surveyed would consent to negotiating with debt settlement companies. Instead, many creditors just sell the debts to collection agencies. In some cases, you may have better luck negotiating directly with your creditors.
Another reason debt settlement may fail is a debtor’s inability to complete the needed payments into the account set up for the purpose of settlement. These people are already under heavy financial pressure, and should they suffer another setback such as loss of a job or an unexpected medical expense, they may not be able to make their deposits. In this case, they are worse off than when they started, because they are delinquent for nonpayment and have racked up additional interest and penalties.
Interest and fees accumulate while you are paying into the savings account. If you cannot manage to stay on the program for the years needed to complete it, you will then have to deal with this higher balance. Neither will entering a debt settlement company program shield you from debt collectors. You will still face their collection efforts and possibly lawsuits.
Accumulating Interest and Penalties and Tax Obligations
For a case where debt settlement may be “successful,” consider that even if a debt is settled for 50% of the balance, because it takes so long, and because no payments have been made for years, the late fees and interest escalate the debt, so the settlement may actually be more than the original balance. Also, you must pay tax on the amount forgiven, something debt settlement companies are unlikely to tell you.
Any amount forgiven by creditors may be considered taxable as income. Debt settlement company customers sometimes don’t find this out until it is too late. There is an exception for insolvency, where your total debts are more than the fair market value of your total assets.
Alternatives to Debt Settlement Companies
DIY Debt Settlement
Before you turn to a debt settlement company, you could try talking with your creditors yourself to see if you can work out a resolution. Certainly, it’s cheaper, since debt settlement companies take up to 25% of what you owe. But it’s not for the faint of heart. It’s a great deal of work and involves the emotional strain of regularly dealing with debt collectors and creditors, perhaps for years. And whether you or a company do the negotiating, debt settlement will almost certainly damage your credit. Should you decide to try negotiating yourself, here are some tips.
- Be prepared with good records before you call.
- If you are turned down, it hurts nothing to try again.
- Know what payment you can manage and don’t agree to anything you can’t. That’s just putting off the inevitable.
- Call while there is still time. If you don’t pay on your debt for 180 days, your creditor can charge off your debt and sell it to a collection agency. This will cause your credit score to dive. Though settling for less than you owe will also cause a hit to your credit score.
- Before you approach your creditors, make sure you understand the tax ramifications. Consult with a tax accountant before proceeding.
- Try to find some cash to negotiate a lump sum settlement or at least a heft front-end payment. This will make your negotiation likely to be more successful. This may be the time to sell that coin collection or any property you can live without.
- Remember, you probably won’t be dealing with just one creditor. Most people in debt have multiple creditors. To avoid daily phone calls from creditors taking over your life, you might want to route collection calls to a separate number or assign collection numbers to a silent ring. Then once a day, you can pick up your messages and return the calls when it is convenient.
- Explain why you cannot pay the debt. It can’t be because you blew all your money at the track. However, if you have suffered unexpected medical expenses, a job loss or a natural disaster, creditors may understand that you really don’t have the capacity to pay the entire debt.
- Get all agreements in writing. If you reach an agreement with a creditor, get it in writing before you pay them anything.
Many people are afraid to file bankruptcy, because they are afraid to lose their assets. Contrary to what a debt settlement company may tell you, the reality is that most people do not have to part with any of their property. Speak with a good bankruptcy attorney about your situation. One advantage of a bankruptcy over debt settlement is that instead of it taking years, you can get it over with quickly and start rebuilding your credit. Filing bankruptcy also immediately stops harassment from debt collectors, creditors filing lawsuits and wage garnishments. Finally, the outcome, unlike debt settlement, is pretty much assured.
You could contact a non-profit credit counseling organization for help. They can present you with different options. They may on the surface seem somewhat similar to debt settlement companies in that you may be able to make one payment to the organization, and they pay each of your creditors. But they will not advise you to not pay your creditors and become delinquent. Instead they may offer debt management options. They also might be able to negotiate better terms for you. However, these non-profits have your best interests at heart. Debt management can help you with credit card debt but not tax debts, student loans or medical expenses. See NFCC for a list of non-profit consumer credit counselors. Don’t be fooled by scam, for-profit debt management companies.
If you can pay your bills but are struggling a bit, debt settlement is not the answer. You may want to consolidate your debts with a lower interest rate. You could do this with a personal loan or consolidate your credit card debt with a very low introductory offer.
Should You Ever Choose Debt Settlement?
Debt settlement is usually a last resort after your accounts are already delinquent and your credit score is already damaged. It won’t always work, but some creditors will accept a partial payment. If you think debt settlement is the way to go for you, you may want to try to negotiate with your creditors yourself before turning to a debt settlement company. But certainly, you should consider other options including consulting with a non-profit credit counseling organization before taking the risk of entering a debt settlement company program. You can check into a debt settlement company you are considering by contacting your state Attorney General and state consumer protection agency.
Compare the Best Student Loan Refinance Rates
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Student Debt Relief Loan Refinancing Advertiser Disclosure
College Ave: College Ave Student Loans products are made available through either Firstrust Bank, member FDIC or M.Y. Safra Bank, FSB, member FDIC. All loans are subject to individual approval and adherence to underwriting guidelines. Program restrictions, other terms, and conditions apply.
College Ave Refi Education loans are not currently available to residents of Maine.
1 – The 0.25% auto-pay interest rate reduction applies as long as the borrower or cosigner, if applicable, enrolls in auto-pay and authorizes our loan servicer to automatically deduct your monthly payments from a valid bank account via Automated Clearing House (“ACH”). The rate reduction applies for as long as the monthly payment amount is successfully deducted from the designated bank account and is suspended during periods of forbearance and certain deferments. Variable rates may increase after consummation.
2 – $5,000 is the minimum requirement to refinance. The maximum loan amount is $300,000 for those with medical, dental, pharmacy or veterinary doctorate degrees, and $150,000 for all other undergraduate or graduate degrees. Information advertised valid as of 04/26/2019. Variable interest rates may increase after consummation.
3 – This informational repayment example uses typical loan terms for a refi borrower with a Full Principal & Interest Repayment and a 10-year repayment term, has a $40,000 loan and a 5.5% Annual Percentage Rate (“APR”): 120 monthly payments of $434.11 while in the repayment period, for a total amount of payments of $52,092.61. Loans will never have a full principal and interest monthly payment of less than $50. Your actual rates and repayment terms may vary.
ELFI: Subject to credit approval. Terms and conditions apply. To qualify for refinancing or student loans consolidation through ELFI, you must have at least $15,000 in student loan debt and must have earned a bachelor’s degree or higher from an approved post-secondary institution.
LendKey: Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
CommonBond: Offered terms are subject to change. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900). If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown. All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate.
Splash Financial: Terms and Conditions apply. Splash reserves the right to modify or discontinue products and benefits at any time without notice. Rates and terms are also subject to change at any time without notice. Offers are subject to credit approval.com
Earnest: To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest’s fixed-rate loan rates range from 3.89% APR (with autopay) to 7.89% APR (with autopay). Variable rate loan rates range from 2.50% APR (with autopay) to 7.27% APR (with autopay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms of 10 years or less. For loan terms of 10 to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 0.26% and 5.03% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of April 23, 2019 and are subject to change based on market conditions and borrower eligibility.
Auto Pay Discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 04/23/19. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice.
Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 303 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, e-mail us at email@example.com, or call 888-601-2801 for more information on our student loan refinance product.