As BILLSHARK has pointed out many times, when times get tough for ordinary Americans is just when you can count on shady characters to prey on people’s misfortune. The debt settlement industry is no exception. Given the dire economic consequences of the out-of-control coronavirus pandemic, we’re not surprised to see ads for these companies proliferating.
The facts on debt settlement
Here’s the secret: Anything the debt settlement firms can do for you, you can do for yourself, for free, even if your creditors have turned down your request for a settlement before.
And a warning: Not only will you owe the IRS taxes on any amount of money that was “forgiven,” but many of these firms have a history of taking their clients’ fees and disappearing.
If you’re feeling desperate, the ads from these companies can seem like a lifeline. Their promise is that they only they can talk your creditors into reducing the amount you owe, thus “settling” your debt. Because only they know the insider secrets on how to force bill collectors to settle for receiving an amount less than you owe.
These ads, with their breathless promises, are misleading, at best.
Debt settlement pitfalls
One problem is that these firms will often instruct you to stop paying on your debts while they handle them for you. This can ruin your credit score.
They also frequently charge a fee up front—an amount that could range into several thousand dollars—and then fail to deliver on their promises. Although charging a fee in advance is illegal, many still try to get away with it anyway.
Here’s how it works: You are told to deposit an amount into a special savings account for 36 months or more. Often people find they can’t afford to continue in the program and drop out, leaving them worse off than before.
Here’s another little “secret” these firms won’t tell you: If you do succeed in reducing the amount you owe, the IRS can designate the amount reduced as “income” and assess taxes on that amount. For example, if you owe $10,000 and a creditor reduces it to $2,000, you could be liable for taxes on the $8,000 you were forgiven.
The truth is, these firms have no special insider knowledge or relationship with banks that will make your creditors more likely to work with them or approve a settlement. And again, they will charge you thousands of dollars for work you can do yourself.
How to protect yourself
If you still choose to work with a debt settlement company, the Federal Trade Commission (FTC) warns you to avoid any that:
- charges any fees before it settles your debts
- touts a “new government program” to bail you out of personal credit card debt
- guarantees it can make your unsecured debt go away
- tells you to stop communicating with your creditors, but doesn't explain the serious consequences
- tells you it can stop all debt collection calls and lawsuits
- guarantees that your unsecured debts can be paid off for pennies on the dollar
If you do decide to use of these companies, check them out thoroughly with your state’s attorney general (many attorneys general have sued these firms) before you sign anything.
What to do instead
Here are the options the FTC recommends if you can’t handle your debt.
- Talk with your credit card company. Even if you have been turned town before, they may be willing to work with you if bankruptcy is the only alternative (in which they may not get anything). Be persistent and polite, and explain your situation. They could offer you a payment plan on your reduced debt that you can manage.
- Contact a credit counselor. But cautious here, too. “[B]e aware that 'non-profit’ status doesn’t guarantee that services are free, affordable, or even legitimate,” the FTC warns. “In fact, some credit counseling organizations charge high fees, which they may hide, or urge their clients to make 'voluntary’ contributions that can cause more debt.”
- Declare bankruptcy. Some people shudder at the thought of bankruptcy. Some consider those who take this path as “deadbeats” who just want a free ride. But if you’ve been laid off or furloughed and can’t find a new job, it can be a lifeline if you have no other options.
In a Chapter 7 bankruptcy, you can lose your house and your car if they’re not paid off, but you will not face IRS taxes. In a Chapter 13 bankruptcy, the court will approve a repayment play that allows you to pay off your debts over three to five years, without losing your property. After you have made all the payments under the plan, your debts will be discharged by the court.
In either case, you will have to come up with the money (the nationwide average is $1,000) to pay an attorney to file all the paperwork, and your credit score will take a major hit. But if you’ve reached this point, it’s probably fairly low already. Also, be aware that student loans cannot be discharged in bankruptcy.
If you need extra cash to help you through this worldwide financial crisis, let BILLSHARK review your bills. It’s free, and we may be able to find you hundreds of dollars per year you can put toward debt reduction.