Debt settlement firms promise to wipe out what you owe for pennies on the dollar — but anything they can do, you can do yourself for free. Here's how to spot the traps and handle debt the smart way.
1 The Pitch That Sounds Too Good to Be True
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.
2 How Debt Settlement Really Works
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.
3 The Hidden Risks and Tax Surprises
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.
4 FTC Red Flags to Avoid
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.
5 What the FTC Recommends 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 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.
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Frequently Asked Questions
Can I settle my own debt without a debt settlement firm?
Yes. Anything a debt settlement firm can do for you, you can do for yourself for free — even if your creditors have turned down your request for a settlement before. The article recommends talking directly with your credit card company, who may offer a manageable payment plan if bankruptcy is the alternative.
Why is stopping payments to creditors a problem?
Debt settlement firms will often instruct you to stop paying on your debts while they handle them for you. This will negatively impact your credit score. You may also be told to deposit money into a special savings account for 36 months or more, and many people can't afford to continue and drop out worse off than before.
Could settling my debt trigger a tax bill?
Yes. If you succeed in reducing the amount you owe, the IRS may consider the reduced amount as income and assess taxes on it. 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.
What red flags does the FTC warn about?
The FTC says to avoid any firm that charges fees before settling your debts, touts a new government program to bail out credit card debt, guarantees it can make unsecured debt go away, tells you to stop communicating with creditors without explaining the consequences, claims it can stop all collection calls and lawsuits, or guarantees debts can be paid off for pennies on the dollar.
What's the difference between Chapter 7 and Chapter 13 bankruptcy?
In Chapter 7, you can lose your house and car if they're not paid off, but you won't face IRS taxes. In Chapter 13, the court approves a repayment plan to pay off debts over three to five years without losing your property, after which debts are discharged. Both require paying an attorney and hurt your credit score, and student loans cannot be discharged in bankruptcy.
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Debt settlement firms promise to wipe out what you owe for pennies on the dollar — but anything they can do, you can do yourself for free.
You’ve seen or heard the ads: “The secret your creditors don’t want you to know!”.
Sounds too good to be true?.
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.
But if you’re feeling desperate, the ads from these firms can seem like a lifeline.
One problem is that these firms will often instruct you to stop paying on your debts while they handle them for you.
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.
You are told to deposit an amount into a special savings account for 36 months or more.
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.
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.
If you still elect to work with a debt settlement company, the Federal Trade Commission (FTC) warns you to avoid any that.
If you’re so pressed for time or so timid that you think you need a third party to negotiate for you.
Here are the options the FTC recommends if you can’t handle your debt.
Talk with your credit card company.
Contact a credit counselor.
Declare bankruptcy.
In the meantime, let Billshark sic our sharks on your bills.
Yes.
Debt settlement firms will often instruct you to stop paying on your debts while they handle them for you.
The FTC says to avoid any firm that charges fees before settling your debts.
In Chapter 7, you can lose your house and car if they're not paid off, but you won't face IRS taxes.
Billshark negotiates your bills for you — no savings, no fee.
Billshark helps lower internet, wireless, cable, satellite radio, and other monthly bills.
Our experts handle providers for customers and share updates throughout the process.
Customers pay only when Billshark finds savings on eligible bills.
1 The Pitch That Sounds Too Good to Be True.
2 How Debt Settlement Really Works.
3 The Hidden Risks and Tax Surprises.
4 FTC Red Flags to Avoid.
5 What the FTC Recommends Instead.
Frequently Asked Questions.
Can I settle my own debt without a debt settlement firm?.
