If you lost your job, have been unemployed for a while, or became injured or ill, you may have had no choice but to max out your credit cards to pay for basic necessities, such as groceries and gasoline. If your debt is only snowballing, you’re probably feeling overwhelmed right about now.
How are you going to get out of debt? How much of a hit has your credit taken? Now, let’s imagine that you heard about a company that promises to reduce, if not erase your credit card debt for pennies on the dollar. Is it too good to be true?
According to the Federal Trade Commission (FTC), America’s consumer protection agency, you need to slow down. We say, if it sounds too good to be true, it probably is.
About Debt Settlement Companies
The local debt settlement company you hear about is probably NOT a non-profit organization. Quite the contrary, most debt settlement companies are “for-profit” companies where you allow their employees to negotiate with your creditors to accept a “settlement” to cancel out your debt.
When we say “settlement,” it’s another term for a “lump sum payment,” in which case the credit card company would agree to accept a lower amount than what you owe.
In order for you to enter such an arrangement, the debt settlement company would require that you set aside a certain amount of money each month into a special, escrow-like account.
The concept is that you would accumulate enough of a savings that a settlement would eventually be reached. Typically, such debt settlement companies instruct their clients to STOP paying their creditors altogether.
The FTC warns consumers against the following risks involved in debt settlement:
- Usually, debt settlement programs require consumers to deposit money into a special account for 36 months (3 full years) before the consumer’s debts are settled.
- Creditors are not under any obligation to negotiate a settlement for less than the amount that a consumer owes. In effect, a creditor may not agree to settle on a debt.
- It’s common for debt settlement companies to negotiate smaller debts first, thereby allowing consumers’ largest debts to accumulate penalties and interest.
- Since debt settlement companies frequently encourage debtors to stop making payments to their creditors directly, consumers’ credit scores can take a big hit.
- Debt settlement does NOT stop collection activities, such as letters and continuous collection calls.
- Unpaid creditors can sue debtors for repayment, resulting in wage garnishments and liens on their homes.
Considering Bankruptcy as an Alternative
Credit counselors and financial experts say that in many cases, declaring bankruptcy makes the most financial sense. Chapter 7 bankruptcy allows low-income filers to discharge (erase, wipe out) most of their unsecured debts, while Chapter 13 allows higher-income filers to pay off all or a portion of their debts over a 3 to 5 year time period, often without having to surrender any property.