There are many offers on TV and radio from companies offering to negotiate your unsecured debt for “pennies on the dollar,” reducing balances by 50% or more. Is this for real? What’s the catch? How would this affect your credit rating?
These are some great questions recently submitted via Ask One Money Design. As a reminder, you can ask an anonymous question about personal finance and we’ll do our best to answer it for you. Click here to submit a question.
There definitely are plenty of companies out there that want to settle your debt for you. It can be confusing when browsing the internet looking for answers to credit card debt problems. But most are not serving in your best interest and the chances are low you will come out on the other side in better financial shape!
Consider what happened at National Consumer Council, which was shut down by the Federal Trade Commission in 2004 on accusations of falsely claiming nonprofit status. The company’s court records show that only 1.4% of the consumers who signed up for the program ever completed it. Nearly half — 42.9% — dropped out, paying an average of $1,780 in fees and saving $966 in their escrow accounts.
It’s shocking to see the amount of money paid for such debt settlement services you may be able handle yourself or with some trusted help. I’m accustomed to hearing Dave Ramsey preach against such companies. Dave never has kind words for them and always recommends you do the negotiating yourself.
How does debt settlement work? Basically, the company negotiates what you owe your creditors to a lower amount. You pay the debt settlement company who then escrows your money until there is enough to pay the creditor. Once there is enough the loan is paid off. But, there are all sorts of problems created with debt settlement and this approach. I’ve highlighted some of those problems found in an MSN Money article:
- The fees are pricey and difficult to understand. Apparently, all these companies use a wide variety of pricing models. See new FTC rules for recent changes.
- Creditors can still try to collect when the debt is in settlement and hasn’t been fully paid. This can take a while since you’re saving money with your debt settlement company to pay the negotiated amount [while they are taking out their fees from your savings].
- The creditor could still end up suing you until the balance is paid. If you get sued the debt settlement company will drop you because they can’t provide legal advice.
- It is damaging to your credit because creditors won’t settle unless you’re behind on your payments.
- Any forgiven balance could be subject to taxes.
Alternative approaches to working with debt settlement companies:
So, if there are so many problems with debt settlement companies, what are some viable alternatives that can leave you in a much better financial position?
Handle the situation yourself
I recently posted an article on how to deal with creditors [with video from Crown Financial Ministries].
Here are some tips from that article:
- Keep talking to creditors. Establish a dialogue and stay in communication.
- Let them know the details on your loan. Let them know you have all the information such as the account number, amount owed, etc.
- Tell them about your circumstances. They need to understand your situation and who else you owe money to.
- Establish a payment plan and show that plan to them. Let them know when you think you can pay them and when the debt will be paid in full.
If you are going to negotiate with your creditor yourself, make sure you follow these guidelines [from Dave Ramsey]:
- Never give them electronic access to your bank account.
- Get every agreement in writing.
- Never pay until you have the agreement.
Dave Ramsey [from the Ask Dave iPhone App]–
If they are down to the point of suing you, you’re probably over a year behind. It’s likely they’ll take 50 cents on the dollar at this stage of the game.
Do keep this in mind – It’s your debt and you should be responsible for paying it all. I would encourage you to pay all your debts in full when you have the means to do so. Furthermore, if you’re a Chrisitian,the Bible says we are to pay all we owe.
The wicked borrow and do not repay, but the righteous give generously (Psalm 37:21 NIV)
Work with others
If you’re not having much success on your own there are a couple of other approaches to consider:
Non-profit consumer counselor
You can contact a credit counselor. I recently wrote an article for Bible Money Matters with tips to pick a credit counselor. The number one tip is to work with a nonprofit organization such as Credability(formally known as the Consumer Credit Counseling Service). Credability will help you establish a debt repayment plan. They will not help you settle your debts for less or provide you a loan to make the payments. You must have enough money to make the payments each month to Credability who will then pay your creditors based on an agreed upon plan.
Or, you can consider working with a budget coach to help you create a plan [Crown Financial Ministries has a great program – Money Map Coaching]. Many times such a person will help you create a monthly budget, track your spending and also build a plan to get out of debt.
In summary, if there isn’t enough money to pay the debt each month after reviewing your budget, you’ll have to do one o f the following:
- Find a way to increase your income.
- Work with a nonprofit credit counselor.
- Negotiate the debt yourself.
A last resort option should be bankruptcy.
My recommendation is to avoid working with debt settlement companies. Most of these companies are making money off of people with financial difficulties. Such people need guidance, coaching and counseling as well as every penny possible to pay off their debts.
What are your experiences with debt settlement companies? Are you for or against them?