Debt Settlement

Those of you who follow this blog must realize that I am a suspicious soul. I have read about debt settlement companies and have even talked with one of them. I must admit my bias. One of my friends tells me from time to time that skepticism is not a spiritual gift. That said how does debt settlement work?

A company will offer to lower your credit card debt and your monthly payment. If, for example, you have $10,000 on a credit card, you have missed a couple of payments, and debt collection agencies are harassing you daily, you can call up one of these companies and they will make the following offer. We guarantee we can lower your monthly payment to $180 a month and in 36 months your debt will be completely repaid. In other words, you will settle a $10,000 debt for $6,480. Unpacking this offer a little further, I discovered that this one particular company has a relationship with some of the major credit card issuers but not with others. If you have a credit card from one of the companies in their network and they take you on as a client, they will immediately negotiate a $5,000 settlement (or maybe less, you’ll never know) with the credit card company and charge you a 15% fee on the original balance, in this case $1,500. Not surprisingly, their fee is the first thing they collect from your payments.

Sounds too good to be true, well, first of all this is something you can do yourself. Right now, the card companies are looking to clean their books and get rid of customers like you before the new law takes effect in February. This week Citibank raised the interest rates on millions of their card holders, even those with excellent payment records, apparently just to get ahead of the law. Today, companies will settle for as little as 25% of your balance, if you can pay that amount off in a lump sum, although 40%-60% is more common.

I would personally recommend that if you are in really bad trouble, seek the help of a certified credit counselor at a nonprofit agency. They will develop a personal debt management plan for your particular situation. This service should never cost more than $50 a month and frequently $30 a month or less. Know who is working with you. Research them thoroughly with the Better Business Bureau. There are a lot of dubious characters and outright criminals working in the debt relief business. Make sure you get everything in writing and make sure you understand it. Some of these companies will actually pay off the original creditor, then sell the balance of your debt to another collection agency!

If you decide to use a debt settlement service, you will no longer be threatened by collection agencies, your credit report will no longer show a current delinquency, and you will really save yourself some money. However, you will not save as much money as the pitch would lead you to believe. All of that forgiven debt is considered taxable income by the Internal Revenue Service. They will send Uncle Sam a 1099-C form indicating the amount of your windfall and you will have another debt to worry about. Please talk to a qualified tax accountant before signing anything. Finally, utilizing this service will wreck your credit score. A debt settlement rather than a debt payment will be placed on your record.

And, Hey! Let’s be very careful out there.