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Debt reduction services, also known as debt settlement companies, often seem like a dream come true. Once you meet with them and share your financial struggles, they promise to negotiate with your creditors, consolidate your bills, and help you get out of debt. Many of these companies even promise to make your debts disappear, guaranteeing they can help you settle for 30 – 50 percent of what you owe.
Unfortunately, these services aren’t always what they seem. As the Consumer Financial Protection Bureau (CFPB) notes, working with a debt reduction service may even leave you deeper in debt than when you started.
Before you sign up for help with your debts, it’s important to understand how debt reduction services work – and how they turn a profit. Here’s the skinny on debt settlement companies and why they may not be the best deal:
While these firms promise to save you money, they don’t provide their services for free. Worse, many debt reduction services will only help you if you pay hefty fees upfront – even before they get to work.
According to the Federal Trade Commission, the practice of collecting fees before performing any services is actually prohibited under the FTC’s Telemarketing Sales Rule (TSR) for companies who engage in telemarketing these services. As the FTC and CFBP agree, you should steer clear of any debt reduction service that requires any payment upfront.
The FTC notes that debt settlement programs have been known to engage in deception to get new clients on board. They might promise or “guarantee” to settle your debts for a small percentage of what you owe, for example. Or, they might talk about a new program aimed at helping people just like you.
According to the FTC, you should avoid doing business with any debt reduction service that touts a “special government program” that might help you or makes specific guarantees or promises. Since each debt situation is unique and no service can guarantee any outcome, any firm that makes promises is being untruthful. Consult professional tax debt experts with good reputations.
While having debts forgiven or settled can absolutely save you money, forgiveness isn’t always free, either. There could be tax consequences for your forgiven balances, notes the CFPB. “If a portion of your debt is forgiven by the creditor, it could be counted as taxable income on your federal income taxes,” they write on their website.
As a result, you should consult a tax advisor or tax attorney to learn how forgiven debt affects your federal income tax before you sign up.
While all debt settlement firms work differently, most tell you to stop paying your credit card bills or communicating with your creditors as the process begins. Make no mistake that avoiding credit card bills and other debts will hurt your credit score. It’s not a matter of “if” – only “when.”
If any debt reduction service tells you to stop talking to your creditors, you should see that as a red flag, notes the FTC. The best way to get out of debt is to keep communication lines open, and that includes talking to your creditors to help them understand your issues.
As mentioned already, working with debt settlement companies has left many people with more debt than when they started. Why? Because not paying your credit card bills and other debts means incurring late fees, penalty interest, and other charges. And if your debt settlement company fails to perform, you’ll be on the hook for those charges in the end.
If your debt is out of control and you aren’t sure where to turn, the CFPB suggests checking out consumer credit counseling services as an alternative. These non-profits will attempt to work with you and your creditors to strike a compromise you can afford, notes the CFPB. On top of that, they may also help with budgeting and provide other financial tips and strategies that can help your finances improve.
Speaking to a bankruptcy attorney is another option to consider depending on the severity of your debt, they note. While filing bankruptcy should be your last resort, it can’t hurt to weigh your options and speak with a professional who works directly with consumers who have unmanageable debt. And often, you have nothing to lose. “Some bankruptcy attorneys will speak to you initially free of charge,” notes the CFPB.
If your debts aren’t that substantial and your credit is in debt shape, you can also consider a balance transfer credit card with 0% APR for temporary relief. With these offers, you can transfer your debts to a single credit card that offers 0% APR for anywhere from 12 -21 months.
While these cards won’t provide a permanent solution to your debt woes, they can slash your interest payments temporarily and help you pay down debt faster. As always, make sure you read the fine print and understand any offer thoroughly before you sign up.
As a final option, you can also consider a debt consolidation loan. Keep in mind, debt consolidation is the process of combining several debts into one loan with a lower interest rate. While this process won’t erase your debts, it can simplify your bill-paying process, help you save on interest, and get you out of debt faster.
If you’re struggling with debt and looking for a way out, working with a debt settlement firm might seem ideal. But as we’ve shared already, there are plenty of reasons to be skeptical about the services these businesses offer.
If you want to get out of debt and can’t seem to get ahead, make sure to explore all your options including credit counseling, balance transfer credit cards, and even bankruptcy. Most of all, be careful to not fall for the hype, believe any outrageous claims, or fall victim to a debt settlement scam.
When something seems too good to be true, that’s because it usually is.