What debt settlement really does to your finances.
A solution that seems to simplify complex debt problems, but has massive negative consequences.
What is debt settlement (also known as debt relief)?
Overwhelmed with credit card debt and the accompanying worry about how to pay it off, many people turn to debt settlement companies to alleviate their financial problems. In turn, these companies advise consumers to stop paying their credit card bills—and pay them instead.
Contracts are signed and hefty service fees assigned—fees that average 20%-25% of the original debt. The price tag for consumers: hundreds, often thousands of dollars.
“Debt settlement and similar programs…often do more harm than good and turn out to be a waste of money,” Andrew Pizor, an attorney for the National Consumer Law Center, said in a statement quoted in a 2019 Washington Post article. “So while you wait—sometimes for years—to see if debts can be settled for less than you owe, your debt burden may actually grow heftier.”
In 2019, the Consumer Financial Protection Bureau sued Freedom Debt Relief, LLC, the nation’s largest debt-settlement services provider, accusing the company of many offenses, including misleading consumers about their ability to negotiate directly with creditors, and charging customers even after having them negotiate their own settlements. Freedom Debt Relief agreed to pay $20 million in restitution to affected consumers, as well as a $5 million civil money penalty.
How does it work?
Debt settlement companies instruct you to stop paying your creditors, and start setting money aside in a “debt relief fund” that they manage. They tell you not to communicate with your creditors, but in the meantime, your creditors give up on you paying, close your accounts, and sell your debts to collection agencies. That’s exactly what the debt settlement company wants. Why? Debt settlement companies know that collection agencies will almost always settle for about 50% of the amount you owe. If the debt settlement company can make a deal to settle for 50%, they collect their fee, which is 20-25% of the amount of the original debt. So, if you use their services to settle $10,000 of credit card debt, the collection agency gets $5000, and the debt settlement company gets $2,000-$2,500.
The problem with debt settlement.
There are serious consequences to your pocketbook and your credit with debt settlement.
Severe damage to your credit score.
When you stop paying your debt your credit score plummets. The first payment that’s 30 days late can lower your score by 100-125 points, and your score will continue to go down. When your debt becomes a collection, that lowers your credit score by another 40-45 points.
An opportunity for lawsuits and garnishments.
When you stop making payments, you open yourself up to unnecessary risk. Your creditors can take action against you for non-payment. They can file a suit against you, and, in some cases, get court orders to garnish your wages,
Loss of available credit.
When your credit cards close, you lose an important asset–a safety net of available credit to fall back on in an emergency.
Enormous fees for something you can do yourself.
The debt settlement company wins big when they settle with a collection agency. They get a fee equal to 20-25% of the original debt. What consumers don’t know is that collection agencies are likely to settle with anyone for 50% of what’s owed. There’s no need to pay a third party to negotiate on your behalf. If you offer a collection agency 50% of the amount you owe, a collection agency will typically say yes.
What you need to know.
At Working Credit, we take a dramatically different—and more lasting–approach to burdensome debt. We recommend strategies that may take a little time, but meet two goals—protect your credit score, which is vital to long-term financial health, and preserve a safety net of available credit—one or more credit cards you can use in a crisis. We explain options, such as debt consolidation loans, 0% balance transfer credit cards, and proven debt repayment methods (avalanche and snowball strategies). We help you create a plan for your specific situation and then help you see it through.