Should You Use a Debt Settlement Company?
If you are drowning in debt, the prospect of having someone else take care of the problem can be appealing. Debt settlement companies not only promise to work to get your debt paid off, but they also say they could reduce the amount you owe by thousands of dollars.
While debt settlement companies offer legitimate services, some firms may make promises they can’t keep. In some situations, you may be able to get similar results by calling companies directly.
Learn more about debt settlement companies and whether you should be using one.
How Do Debt Settlement and Debt Relief Companies Work?
Debt settlement companies work with creditors to negotiate the terms of your debt to make repayment more manageable. On average, including fees, consumers save 30% off their original debt, according to the industry group American Fair Credit Council.
The process for debt settlement usually follows these steps:
- A consumer applies to a debt settlement program, and the company determines whether it thinks it can be successful in obtaining debt relief.
- Once a consumer enters into an agreement with a debt settlement company, they are advised to open a separate bank account to be used for payment.
- Representatives from the debt settlement company contact creditors to negotiate repayment terms.
- When a consumer agrees to the negotiated terms, the money is paid out of a separate bank account.
- Once the settled amount is paid, the creditor will report to the credit bureaus that the account was settled for less than the full amount.
- The debt settlement company assesses a fee for their services.
Fees for debt settlement services are usually charged as a percentage and can be as much as 25%. Depending on the company, that may be a percentage of your overall debt or a percentage of the amount saved. On average, the AFCC says consumers save $2.64 for every $1 they pay in fees.
Pros and Cons of Debt Settlement and Debt Relief Companies
Before you sign up with a debt settlement company, make sure you understand both the benefits and drawbacks of their services.
The pros of debt relief companies include the following:
- Ease of use: With a debt settlement company, you let the business do all the difficult work of negotiating down your payments.
- Lower debt: If successful, a debt relief company can significantly reduce the amount of money you owe and, depending on your circumstances, keep you out of bankruptcy.
However, debt relief services can also come with significant drawbacks. Here’s a look at some of the cons:
- Expensive: Depending on the size of your debt, you could pay thousands for debt relief services. This may include a percentage fee as well as monthly fees for managing a separate bank account from which to pay your debts.
- Higher credit costs: To create leverage for negotiation, debt settlement companies might ask you to stop making payments. That could add late fees and penalty interest charges to your account and may offset any savings.
- Lower credit score: If you stop making payments on debt, not only could it cost you more money, but it could lower your credit score substantially.
- Legal risk: Not all creditors will work with a debt settlement company, and if you stop making payments, you could be at risk for a debt collection lawsuit.
- No guarantees: There is no guarantee that a debt relief company will be successful. That could leave you with more debt than when you started.
If You Decide to Use a Debt Settlement Company
Using a debt settlement company usually only makes sense if you have a significant amount of unsecured debt. The typical client for debt relief services may have seven accounts – including at least one that is delinquent – and more than $25,000 in unsecured debt, according to the AFCC. If you only owe one or two thousand dollars, these services may not be right for you.
When reviewing companies, make sure you do the following:
Consider members of the AFCC
Companies can be either members or accredited members of the AFCC, and these designations may indicate the firms have high standards and adhere to industry best practices.
Check reviews
Search the Better Business Bureau, Google, or social media for reviews of the company you’re considering. Does it have a pattern of the same complaints and how does it respond to customer issues?
Understand the fee structure
Be sure you understand how the company operates, particularly when it comes to fees. Does it charge based on a percentage of your total debt or only the amount negotiated? The answer could be the difference between thousands of dollars.
Read the fine print
Debt relief companies are required by law to provide certain disclosures. These cover how much the company charges and when you can expect to see results, among other things. Make sure you actually read through this material and understand it before signing on the dotted line.
Debt Settlement Red Flags
Not all debt settlement companies are created equal, and some unscrupulous businesses prey on unsuspecting people. The following are all red flags that indicate you should keep looking for a different firm:
- Guarantees that it can settle all your debt or make your debt disappear.
- Promises a specific percentage reduction in your debt.
- Says it can eliminate all debt collector calls and lawsuits.
- Tells you to stop talking to creditors.
- Charges a fee before any debt settlements have been made.
- Advertises a “government program” to eliminate debt.
Debt relief companies can reduce the amount you owe, but creditors aren’t required to work with them so there can be no guarantee of specific savings. Be cautious of any company that makes debt settlement sound like a foolproof process.
How to Settle Your Own Debt
The services offered by debt settlement companies can be valuable, but they aren’t anything you can’t do for yourself.
To settle your own debt, your account typically needs to be at least 90 days delinquent. If your debt meets this criteria, use the following steps to settle the account:
- Know how much you can pay. Many creditors will want a lump sum to settle an account so make sure you have enough money available.
- Contact the creditor or collection agency to make your offer. Often, settlements may be for 40-50% of the amount owed, and it is a good idea to start by offering a lower amount. The creditor will likely try to negotiate a higher payment.
- Recognize that it may take several calls to reach a representative or manager willing to work with you.
- Document all your calls, including the time and to whom you spoke.
- Ask that the account be reported to credit bureaus as “paid as agreed” to minimize potential damage to your credit history.
- Once an agreement has been reached, get the details in writing.
- Make your payment(s) as promised to complete the deal and confirm that it is reported properly by requesting a copy of your credit report.
Alternatives to Debt Settlement Companies
Settling debts on your own isn’t your only option if you are over your head in debt. You could also try the following:
Consolidate debt: If you are having trouble making payments on multiple high-interest credit cards or accounts, try to consolidate your debt into a low-interest loan or 0% APR credit card. That can make your payments more manageable, but if your credit score is low, it may be difficult to get approval for a new account for debt consolidation.
Use credit counseling: Non-profit credit counselors can provide tips to help you manage your money and get out of debt. Look for an accredited or certified agency such as members of the Financial Counseling Association of America or the National Foundation for Credit Counseling.
File for bankruptcy: Although a last resort, if you don’t have money to offer a settlement and don’t see any hope of paying off your debt, you could file for bankruptcy. This process can be lengthy and bankruptcy will stay on your credit report for 10 years, but it can also provide a financial fresh start.
Resources
Other websites with helpful information and resources regarding debt settlement include the following:
American Fair Credit Council: An industry group, AFCC offers information on the debt settlement process and makes it easy to search for debt settlement companies.
Better Business Bureau: Before signing up with a debt settlement company, check the Better Business Bureau to see if it has a pattern of consumer complaints.
Consumer Financial Protection Bureau: This government agency was created to ensure financial institutions treat consumers fairly. In addition to providing educational resources, the bureau maintains a database of consumer complaints.
Federal Trade Commission: Further information about settling debts can be found on the FTC website.
New York Attorney General: Debt settlement tips from the New York Attorney General can be found here.
