Debt Settlement Sets a Costly Trap
by David Tenenbaum
They're young. They're smiling. And they're groovin' on the road to being debt-free. Want to see this carefree couple? Head for Google, type in "debt settlement," and click the sponsored links.
The Web site of one debt settlement outfit uses a subtle pitch: "More often than not" debt settlement "proves to be the very best means to solve serious debt problems, but you have to be careful."
No kidding. The "debt-settlement" industry is growing fast, but it's a trap for the unwary.
Debt-settlement companies promise "Reduce Debt 40-60%" or "Debt Relief--Save up to 75%."
Any of this might happen. But it's also possible your creditors will decide to forgive your entire debt. It could happen, but it's just not likely.
It's an irresistible pitch, but there are five major catches:
Creditors don't see any payments until you decide to settle, so they may get increasingly frantic. That raises the possibility of more late fees and higher interest rates. The creditor even may send the debt to a collection agency. But you won't know about that, says Kenneth King, executive director of Consumer Credit Counseling in Sheboygan, Wis., because the communications will be going to the debt-settlement firm, not to you.
Few creditors are willing to settle for such chump change.
If they are, you can negotiate this settlement yourself, without paying the settlement company.
If the debt does get settled at a discount, your credit rating will reflect your partial payment.
And then you will owe income taxes on the discount.
Debt settlement has earned its poor reputation, says Ken King. "They take advantage of people. In most cases, the consumer is misled into believing [he or she is] going to be able to reduce the debt without affecting their credit." But despite the "large up-front fee, and monthly maintenance fee, the consumer seldom receives any benefits."
Ask the professionals at your credit union about credit counseling options.
With debt settlement, "All the responsibility lies on the consumer," Ken King says. "The company gets the fee, takes the money, and I'm supposed to call them when it's time to settle, and have accumulated enough money to settle." But after paying the fee, he says, "I may not have anything left to settle with."
Nothing left
The new, more stringent bankruptcy law has focused attention on alternatives like credit counseling, debt management, and debt settlement, say Kathleen King (unrelated to Ken King), who deals with credit issues as the loss prevention manager at Citizens Credit Union in Kalamazoo, Mich. But she argues that the main selling point of debt settlement, the sterling credit rating, is an illusion. "In most cases, people have hired a company, and it has presented itself as having the ability to clear the credit, but it does not do that. The credit agency is not required to record the debt as 'paid in full,' just as 'settled for less than full balance.' "
A debt settlement company doesn't do anything you couldn't do yourself.
Before unsecured debt, typically from credit cards, starts to get out of control, Kathleen King suggests starting credit counseling, or talking to a reputable debt-management service. The name sounds like debt settlement, but she says the service is different. Both firms negotiate with creditors, but debt management firms avoid those "something-for-nothing" promises. A debt management firm will ask creditors to "re-age" the account and make it current, which removes the late fees and returns the interest rate to normal. That way, the payments go toward principal, not fees and interest.
Warnings about the Web
Kathleen King also cautions about searching on the Internet for a debt management firm. "We recommend a debt management company in town; all the credit unions in town are working with this company; they do such a wonderful service." The people at your credit union can recommend a debt management agency if you need one; some credit unions even offer debt management service.
Furthermore, any effort to deal with debt must be comprehensive, she says. Unless all the creditors are paid, the credit rating still will be stained. "We want to address the entire situation ... it should not be a matter of paying the one that's screaming the loudest."
It's probably not surprising that debt settlement is seemingly so attractive in our culture. In 2005, the personal savings rate of Americans fell below zero for the first time since the Great Depression. The Commerce Department reported that Americans spent more than they saved, with the result that the national savings rate stood at minus 0.5%. The news did not make the front page, however.
You'll owe income taxes on the amount of debt a settlement agency manages to discount.
If your debts are crowding in on your life, both Kings suggest contacting a credit counselor through your credit union. Many credit unions have credit counselors on staff and those credit unions that don't can refer you to a credit counselor who can help. With restraint, reason, and some hard work, you probably can get your financial affairs back on a solid footing. But paying someone to do what you can do yourself, or expecting to get something for nothing, will only worsen your credit woes.
"The key is having the money, and with debt settlement, you get caught in the scam of giving someone else the money," adds Ken King. It sounds too good to be true, and it is.
Someone will make money off the deal, he says, but it won't be you.
April 24, 2006
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