If you are experiencing financial difficulty, you may be tempted to use a debt relief company to help take care of your bills. Often times, settling with your creditors is a good alternative to filing bankruptcy. However, before you hire a company to help with your debts, you should first understand the differences in services that debt relief companies claim to offer, as well as the potential risks involved. This article discusses three basic types of debt relief schemes.
To learn more about negotiating with creditors and settling debts, see the articles in our Debt Settlement & Negotiation With Creditors topic area.
Debt negotiation, or debt settlement, programs work by modifying your existing credit cards, loans, or other debts, in the following ways:
reducing monthly payments
reducing or waiving finance charges and late fees
negotiating lump sum settlements, usually at a reduction of 50% or more of the principal balance, or
a combination of all the above.
Lump sum settlements and payment plans are frequently accepted by creditors. You can directly negotiate with them yourself, without having to use a debt relief company.
If you do decide to hire a debt relief company, use caution. Here's why.
Debt settlement companies often charge large fees up front for its services.
While it is not uncommon for debt relief companies to charge upfront fees, some disreputable companies will then disappear and never perform the promised services. Or companies promise to use some or all of the fee it charges you to pay your debts, but then pocket the money instead of paying your creditors.
Go with a company that provides detailed disclosures on how the fee is charged and spent. Some debt settlement companies agree to defer their fee until after a settlement or payment plan has been reached.
A debt relief company may tell you to stop making payments to your creditors. If you have already fallen behind on payments, then this is not an issue. But if you are current on your payments, this poses a dilemma.
Some creditors won't give you the best deal if you are a “good consumer.” They have a policy of refusing to reduce balances or interest rates below a certain amount unless a borrower is in default, the theory being that you are in good financial shape if you are current on your payments. They will not agree to major reductions of balances, finance charges, or payment plans unless you show a financial hardship by way of a default, often of 90 days or more. Creditors sometimes call this being “90 days out.”
A debt relief company may exploit this industry secret by advising you to default on all of your debts for 90 days, and then use this money to pay the debt settlement company instead. But by intentionally defaulting, you risk damaging your credit history and incurring default-rate finance charges and late fees.
If you are already having financial trouble, then this might not be a big issue for you. However, if you are not already in default, you should avoid this strategy. Here are some tips to effectively maneuver the default tango using a debt relief company:
Do not stop making payments to your creditors unless a specific creditor specifically conditions a desired settlement upon a default.
Carefully weigh all of your settlement options (payment plan vs. lump sum settlement) with the debt relief company, preferably using a budget.
Debt settlement is a last resort. You may be better off going with a reduced interest rate/payment plan rather than sacrifice your good credit with debt settlement.
Unfortunately, some debt relief companies will take the money and run, never once speaking with the creditors that they agreed to negotiate with on your behalf. A debt relief company may make you feel so comfortable that you stop communicating with your creditors. Don't. Stay in close communication with your creditors during the negotiation process.
Some debt relief agencies offer to consolidate your debts for you. They promise to pool all of your debts together so that you make a single payment, to be shared by all of the creditors. While a consolidation of your debts can potentially save you a lot of money, there are many disadvantages.
Consolidations usually cover only unsecured debts like credit cards. They do not cover big expense debts like mortgages and student loans.
Creditors are not required to participate in the consolidation. If one of your creditors does not agree to be a part of the consolidation, you will have to deal with it separately.
Consolidations are not necessarily final. You are still exposed to lawsuits, judgments, liens, and other collection actions even after making your consolidation payments.
The fees a debt consolidation company charges you may be so high that it cancels any savings under a new consolidation plan.
Learn more about debt consolidation scams.
Treading into fantasy territory, there are some companies that claim to completely eliminate your debts. Not to be confused with debt elimination plans that provide for controlled spending and a structured payoff of your debts, a debt elimination scheme usually involves an upfront fee for a document that purports to be a legal declaration that the debt is eliminated. Unless the person advising you is an attorney or there is some legitimate legal basis for not paying a particular debt, you should immediately walk away from any such promises.
Getting the right kind debt relief is not easy. It involves time, careful planning, and full consideration of your legal rights and financial abilities. Many debt relief schemes, even if done perfectly, may not fully address all of your problems. Despite the allure of their promises, you could wind up in worse legal and financial shape than when you started. Instead, consider other options for getting your debts under control, including:
dealing with the creditors directly yourself (for tips on how to do this, see our Debt Settlement & Negotiation With Creditors topic area)
consulting with local consumer credit counselors, home mortgage assistance agencies, and similar nonprofit programs
talking to an attorney, who can offer a wider range of debt-related representation such as potential consumer law and contractual issue defenses, or