Reduce your debt by 60%! Stop collection calls! Be debt-free in 12 months!
Tempting as the ads may be, however, debt-settlement companies can leave you in an even worse mess. Many are outright scams.
"If a company's making big promises, it should raise red flags," said Alison Southwick of the Better Business Bureau. "Getting out of debt is not easy. It takes time."
Still, it's no surprise that people are vulnerable to promises of relief. It's probably why complaints against debt-settlement services rose by almost 19% in 2008 over the previous year, according to the BBB.
Before you pick up the phone, here's what you need to know.
How it worksThe premise is that debt settlers will negotiate with lenders, usually credit card companies, to whittle down your balance. You pay the negotiated amount in a lump sum. Some companies promise to lower your debt by as much as 70%.
The incentive for lenders is that they salvage at least part of what they're owed.
Prices vary, but a company might charge you up to 20% of however much you owe. So the fee for settling a $10,000 loan might be $2,000. Fees are usually demanded upfront before a settlement is delivered.Apart from the fact that a settlement might never be secured, the offer is riddled with traps (more on that later).
You should know that the BBB automatically lists all debt-settlement companies under its new "inherent problem" category, meaning the bureau has concerns about the entire industry.
Companies can apply to be removed from the category by demonstrating they deliver on their advertising claims. None has been removed yet, though some are in the application process.
Some better alternativesThe bottom line is that there's no need to hire anyone. You can negotiate a settlement directly with your lender.
"They have a complete picture of your finances. They will know if you're a candidate," said Gail Cunningham of the National Foundation for Credit Counseling, or NFCC, a nonprofit group based in Silver Spring, Md.
Before you even reach that point, however, be sure to exhaust all other options. A negotiated settlement comes with serious consequences and should be a last resort.
If you feel overwhelmed, ask for a free consultation at a nonprofit credit-counseling agency. You might be able to develop a budget that lets you meet your debt payments if you work with a counselor.
You can search for a local agency through the NFCC or the Association of Independent Consumer Credit Counseling Agencies.
If a tightened budget doesn't do the job, a debt-management plan might be in order. This is when you and your lender agree to more-manageable repayment terms, usually over a longer period.
The credit-counseling agency will likely charge a monthly fee of about $20 to work out a management plan, but the fee can be waived if it's unaffordable. The plan will be noted on your credit report, but it won't hurt your credit scores.
You could also try negotiating a loan modification directly with your lender. Banks have gotten more flexible about adjusting terms in the past year or so. A modification can include a lower interest rate, the elimination of fees or a reduction of the monthly payment.
If you decide that a debt settlement is your only option, call your creditor directly. Some credit card companies refuse to work with settlement firms, Cunningham said. So if you hire one, you might be throwing your money away.
A lump-sum payment is usually required, but you might be able to pay the amount over a couple of months.
The repercussionsHiring a debt-settlement company won't stop the collection calls. Even as a company tries to negotiate, collection notices can still arrive, interest and financing charges can rack up, and your lender might even sue you.
Aside from the fees you pay, the total amount of your debt is likely to grow, too, if a settlement isn't reached.
And it usually takes about three years to complete a settlement, said David Leuthold, the executive director of The Association of Settlement Companies, an industry group of about 200 debt-settlement companies. That's because clients typically don't have enough money to pay the settlement amount demanded by the creditor right away. So the settlement company will run interference while the client saves up that money.
The strategy might not make sense to a lot of people. But Leuthold said people nevertheless use settlement services because they're daunted by the prospect of dealing with creditors on their own.
It's not all roses even if you do get a settlement. It will be marked on your credit report for seven years and can hammer your credit scores.
Coming regulationsThe Federal Trade Commission is reviewing regulations for the debt-settlement industry. One proposed rule, for instance, would ban companies from taking fees before services are rendered -- a common practice now.
"That's before you know whether anything is going to be successful," said Susan Grant, a spokeswoman for the Consumer Federation of America, an advocacy group based in Washington, D.C. "In some cases, it's quite possible that no results are achieved."
Cuomo said Nationwide Asset Services had failed to deliver on promises to reduce debts by 25% to 40%. The attorney general said fewer than 1% of its 2,000 New York customers saved that much.
At the very least, the case should be a warning to anyone considering debt-settlement services.
Published Nov. 12, 2009