Beware of Debt Relief Services

Learn about debt relief services, regulations affecting these types of services, why you should generally avoid them, and alternatives to using a debt relief company.

By , Attorney (University of Denver Sturm College of Law)

You might notice ads for debt relief services, like credit repair services, debt consolidation, debt settlement, and debt management plans, on the internet, radio, or television. If you're in dire financial straits, this type of service might sound like the perfect solution to your debt problems.

But, in many cases, the for-profit companies offering these services are scammers who provide little or no help after you've agreed to pay them. Even if a debt relief company does help you, you'll have to pay a lot for services you could do yourself or would be better off paying an attorney or legitimate credit counseling agency.

Beware of Credit Repair Scams

If you're looking to boost your credit scores and clean up your credit reports, various "credit repair" organizations might offer to help—for a fee. But using a for-profit company that claims it can repair your credit is almost always a bad idea. These companies claim they can fix your credit, but many charge high prices to legally do only what you can easily do yourself, and other companies are outright scams.

No matter how persuasive and attractive a credit repair company's services seem, you'll be better off avoiding these outfits in almost all cases. Here's why.

You Can Repair Your Credit For Free

Even if a credit repair company isn't a scammer operation, it can't do anything for you that you can't do yourself. Credit repair companies usually promise to remove incorrect information from your credit history, but you can easily handle correcting any errors on your own.

Credit repair clinics also often advise debtors to pay outstanding debts if the creditor agrees to remove the negative information from your credit file. While this negotiation tactic is something you might want to consider, you don't need to pay a credit repair clinic for this advice.

Credit repair companies are often more interested in getting paid than assisting you—sometimes taking your money and disappearing—leaving your credit history no better or worse than before. Even assuming that a credit repair company isn't a total rip-off, it can't do anything for you that you can't do yourself. What they will do, however, is charge you hundreds or thousands of dollars for their unnecessary services.

They Make Unrealistic Promises

Credit repair organizations sometimes make assurances that they can remove correct, though negative, information from your credit reports. But if they're accurate, negative items in your credit history can legally stay there for seven or ten years. No one can magically make them go away.

Even if the credit bureau removes information it had the right to include in your file, it's undoubtedly only a temporary removal. Most correct information reappears after 30 to 60 days because the creditor that first reported the information to the credit bureaus will report it again.

They Offer Information You Can Find on Your Own

Credit repair clinics can give you a list of banks that offer secured credit cards, which are credit cards used against a balance you deposit in a bank account. (This is often the first step to getting a major credit card if you have bad credit.)

While this information can be helpful, it's not worth paying for. You can find this information yourself for little or nothing.

They File Frivolous Disputes With Credit Reporting Agencies

Credit repair organizations typically try to take advantage of the law requiring credit reporting agencies to verify information if a consumer disputes it. Sometimes, the credit repair company might challenge most or every item in a credit file (negative, positive, or neutral) to try to overwhelm the credit reporting agency into removing information without verifying it. Or they dispute the same item over and over again.

Credit reporting agencies are well aware of these tactics and can legally disregard these challenges because they're frivolous. And creditors that furnish your credit information to the reporting agencies don't have to investigate your dispute if they reasonably believe it is submitted by, prepared by, or submitted on a form that a credit repair organization supplied. (12 C.F.R. § 1022.43).

You're better off getting copies of your credit reports from the three major credit reporting agencies (Equifax, Experian, and TransUnion) and selectively challenging incomplete or inaccurate items yourself.

They Are Often Sketchy or Outright Criminal

Credit repair organizations sometimes use fraudulent, deceptive, and even illegal tactics.

In a scam called "credit file segregation" or "file segregation," some companies suggest that you create a new identity by applying for an IRS Employer Identification Number (EIN), a nine-digit number that resembles a Social Security number, and use it instead of your Social Security number when you apply for credit. (A business uses an EIN to report information to the IRS.) This practice is illegal. It's a federal crime to make false statements on an application for a loan or credit and to misrepresent your Social Security number and get an EIN from the IRS under false pretenses.

Other companies have been caught stealing the credit files or Social Security numbers of people under 18 or have died and substituting these for the files of people with poor credit histories.

Debt Management Plans

Debt relief companies sometimes offer to arrange a "debt management plan" to pay back your creditors. These plans often include reductions in interest rates or other favorable terms so you can afford repayment.

How Debt Management Plans Work

Here's how a typical debt management plan might work: The debtor deposits money into an account each month. The debt relief company uses the money to pay the debtor's various creditors under the plan. In most cases, the debtor has to make regularly scheduled payments into the account for three to five years. The terms of most plans also require the debtor to pay the debt relief company a fee in addition to the monthly deposits.

Avoid For-Profit Companies

You should generally avoid for-profit companies offering these plans. However, you might consider arranging a debt management plan with an accredited, nonprofit credit counseling agency (see below) after considering all of the pros and cons.

What Is Debt Settlement?

Some debt relief companies claim they'll work out deals with your unsecured creditors to significantly reduce your debts (supposedly) by 50% or more. To get this kind of reduction, they negotiate lump-sum settlements.

How Debt Settlement Works

As part of the process, the debtor usually makes regular payments into a designated account rather than to creditors. Or the company might have you open a savings account in your name and accumulate funds there. Once the account has sufficient money available, based on the debt settlement company's opinion, the company negotiates lump-sum settlements with your creditors. The company pays the creditors—and often themselves—with money from the account.

But what the company won't tell you is that, in the meantime, your debt grows bigger, your creditors might not settle, and its fees are probably high. In almost all cases, it's better to hire a reputable attorney rather than a debt settlement company if you want help negotiating debt settlements.

Possible Tax Consequences of Debt Settlement

Also, one thing to keep in mind is that settling a debt could have tax consequences. The IRS generally considers canceled debt of $600 or more as taxable. Unless you qualify for an exception or exclusion, settling debts for less than you owe might increase your tax liability depending on your tax bracket and the canceled amount.

How Debt Consolidation Works

Companies sometimes offer to reduce your monthly payments by rolling multiple loans together into one. This process is called "debt consolidation," which has some upsides and downsides. You might have other options—perhaps better ones—for getting out of debt trouble rather than consolidating,

Why You Should Generally Avoid Debt Relief Services

Debt relief services are sometimes marketed as "credit counseling services," "debt elimination services," or "debt negotiation services." But no matter what a company calls its particular services, all too often, for-profit debt relief companies:

  • charge high fees for services you could do yourself
  • hurt your credit
  • drop the ball when it comes to actually performing the services or
  • simply take off with your money.

Many scammer companies will advise you to default on your payments while they "negotiate" your debts. In the meantime, your credit scores get worse. Defaulting on your debts will also likely lead to debt collection activities or lawsuits against you.

Signs of a Scammer Company

If a debt relief company makes any of the following claims, it's most likely a scammer.

  • The company guarantees your unsecured debts will be paid off at less than half their value.
  • The company charges large monthly service fees.
  • The company insists that communications to your creditors go through them and won't allow you to make direct payments to your creditors.
  • The company assures you that you won't face creditor lawsuits.
  • The company tells you that its services will improve or have no negative impact on your credit reports.
  • The company claims it can remove negative information from your credit reports—even if the information is accurate.

Federal and State Regulation of Debt Relief Services

Some federal laws, like the Federal Trade Commission Telemarketing Sales Rule and often state laws, protect consumers from debt relief scams.

FTC Telemarketing Sales Rule

The FTC Telemarketing Sales Rule offers limited protection against abusive for-profit debt relief companies. Among other things, the Rule:

  • prohibits covered debt relief services from collecting fees until the company settles, alters, or reduces the debt
  • requires particular disclosures when marketing debt relief services and
  • prohibits specific misrepresentations.

The Rule only applies to for-profit companies, services related to unsecured debts, and services rendered after the debt relief company calls you or you call in response to an advertisement—not if the company communicates with you through the internet or the mail. The Rule also usually applies when the customer initiates a call in response to the company's advertisement through the mail or an email.

State Protections for Consumers

Almost all states regulate debt relief companies, and some prohibit debt settlement companies from doing business. These state laws usually don't apply to lawyers and nonprofit organizations.

State laws that regulate debt relief services often:

  • limit the fees that companies can charge
  • require written contracts
  • require that the debt relief company keep consumer payments in a separate trust account
  • require debt relief companies to post bonds and
  • restrict their practices.

Getting Help From an Accredited, Nonprofit Credit Counseling Agency

If you need help rebuilding your credit or negotiating with creditors or debt collectors, consider talking to an accredited, nonprofit credit counseling agency (or a reputable attorney, see below) rather than hiring a for-profit debt relief service. In almost all cases, for-profit organizations should be avoided entirely, but you need to be wary of some nonprofit ones as well.

Consumer credit counseling agencies are typically nonprofit organizations that offer legitimate help managing unsecured debts. A consumer credit counselor can:

  • go over your current financial situation
  • help you come up with a budget that manages your finances and
  • in some cases, develop a personalized debt management plan to deal with your debts, though the agency will likely charge a fee for this service.

How to Find an Accredited, Nonprofit Credit Counseling Agency

Here are a few ways you might go about finding a legitimate credit counseling agency:

Legitimate credit counseling agencies offer financial help for free or at a minimal charge.

Verify the Company's Nonprofit Status

You can verify nonprofit status through the Internal Revenue Service, but just because the company is a nonprofit doesn't mean it's legitimate. The federal Credit Repair Organizations Act prohibits companies that offer credit repair services from making untrue or misleading representations and requires certain disclosures. Many states regulate credit repair clinics, as well. Some dubious credit repair clinics try to get around these regulations by setting themselves up as nonprofits.

Is the Company Bonded?

You can also ask whether the company is bonded, which some states require. A bonded company has posted money to protect consumers from fraudulent practices, for example, or in case the company goes out of business (or goes bankrupt) and dissatisfied consumers seek a refund.

A legitimate company should be willing to give you the name of its bonding company. Call the bonding company to verify the bond and find out the amount.

But even a bond is no guarantee against poor service or legal difficulties because of something a credit repair company recommended you do. The bond might be too little to protect most of the companies' customers, and getting the bonding company to pay up might require you to file a lawsuit.

Getting Help From a Lawyer

A few standard services that debt lawyers offer are:

  • representing debtors in bankruptcy proceedings (you might want to consider filing for bankruptcy to discharge your unsecured debts)
  • debt management advice, and
  • negotiating with creditors to settle debts. (Remember, if you settle a debt for less than you owe, you might face a tax liability. The IRS generally considers canceled debt of $600 or more as taxable, though exceptions exist.)

Many bankruptcy and debt relief attorneys offer free consultations and will quote you a fee after evaluating your circumstances.

Getting More Information

For information on managing your debt, get Solve Your Money Troubles: Strategies to Get Out of Debt and Stay That Way, by Amy Loftsgordon and Cara O'Neill (Nolo).

For comprehensive information on how to repair your credit, get Credit Repair, by Amy Loftsgordon and Cara O'Neill (Nolo).

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