You’ve seen or heard the ads: “The secret your creditors don’t want you to know!” “We can help settle your debt for pennies on the dollar!” “Don’t file for bankruptcy before you talk to us!”
Sounds too good to be true? Remember what you’ve heard about that old adage: “If it sounds too good to be true, it probably is.”
Here’s the real 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.
Let’s back up a bit. If your car loan and house loan and student loan and credit card debt have truly become way more than you can manage, you need to do something. Bankruptcy is the worst-case scenario (more on that later).
But if you’re feeling desperate, the ads from these firms can seem like a lifeline. The theory is that they can talk your creditors into reducing the amount you owe, thus “settling” your debt. In other words, the creditors will “settle” for receiving an amount less than you owe.
One problem is that these firms will often instruct you to stop paying on your debts while they handle them for you. This will negatively impact your credit score.
They also frequently charge their fee up front—an amount that could range into several thousand dollars—and then fail to deliver on their inflated promises. Although charging a fee in advance is illegal, many still try to get away with this practice.
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. In addition, whether you or a debt settlement firm is negotiating with your creditors, the creditors are under no obligation to agree to a settlement.
Here’s another little “secret” these firms won’t tell you: If you do succeed in reducing the amount you owe, the IRS may consider the amount reduced as “income” and assess taxes on that amount. For example, if you owe $50,000 and a creditor reduces it to $12,000, you could be liable for taxes on the $38,000 you were forgiven.
The truth is, these firms have no special insider knowledge or relationship with the 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.
If you still elect 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 out 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’re so pressed for time or so timid that you think you need a third party to negotiate for you, check them out thoroughly with your state’s attorney general (many attorneys general have sued these firms) before you sign on. But realize there’s nothing they can do that you can’t do yourself.
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 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 beware 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. 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 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.
In the meantime, let Billshark sic our sharks on your bills. We can find you hundreds of dollars per year that you can put toward debt reduction.