The downside of working with debt settlement companies

Working with debt settlement companies can exacerbate your financial problems.

Many people that are struggling with debt that they cannot repay will try anything to remedy their situations. As a result, many are moved to act by commercials advertising companies that promise to negotiate with creditors to settle debts for pennies on the dollar. Unfortunately, the overwhelming majority of people that choose to work with these debt settlement companies (also known as debt consolidation companies) end up in worse financial straits than when they started.

An investigation by the Federal Trade Commission in recent years found that debt settlement companies fail to reduce their customers’ debts in about 90 percent of cases. Why is the failure rate so high? The answer to this question is found in how these companies operate.

Virtually all debt settlement companies advise their customers to quit repaying their debts. By doing so, the company attempts to use the nonpayment of the bills as leverage to force creditors to accept less than the full amount of the debt owed. Unfortunately, the reality is that creditors are not required by law to work out a deal with debt settlement companies.

As a result of this fact, withholding payment of the debts leads to a whole host of negative consequences. Once the payments stop, the customers of the debt settlement companies are often hit with interest and late fees, which quickly cause the debt to balloon. Additionally, the nonpayment encourages the creditors to take action that is more aggressive to collect the debt (e.g. hiring collection agencies, filing a lawsuit), in many cases.

To add insult to injury, working with the debt settlement companies themselves can cause customers’ debts to increase significantly. Since these companies are in business to make a profit, they charge considerable fees, sometimes as high as 15 percent of the debt owed. Unfortunately, these companies expect their customers to pay this fee regardless of whether they are actually successful in lowering the amount owed.

Even in the very few cases where the debt settlement company succeeds in renegotiating the debts, customers can be put in a worse financial position due to taxes. Since forgiven debt is considered income under the tax laws, customers can be hit with an unexpected tax bill while they are still in a fragile financial situation.

An attorney can help

If you are in this sort of financial position, filing bankruptcy is a better solution than working with debt settlement companies. Bankruptcy immediately halts all collection attempts, such as collection calls, wage garnishment and lawsuits. Depending on what type of bankruptcy is filed, most debts are either eliminated outright tax-free or repaid in installments over a three to five-year period, allowing the majority of people to restart their lives again financially.

There are also other non-bankruptcy options available. In some cases, it may be possible to reduce the amount owed through debt negotiation. However, working with an attorney instead of a debt settlement company can assure that creditors are legally bound to honor their agreement to accept less than the full outstanding amount of debt.

If you are among the many struggling with unaffordable debts, contact an experienced bankruptcy attorney before your situation gets worse. An attorney can review your options inside and outside of bankruptcy and recommend the best one for your situation.