How “debt settlement” companies can actually hurt instead of help.

You have heard the ads.  Debt settlement companies promise to “settle” your debt for “pennies on the dollar”.  Their “qualified representatives” are there to help you “legally” settle your debt.  Here is what they don’t tell you and how some of these companies can actually end up hurting you instead of helping you.

Debt settlement companies work by putting you on a program whereby you send them monthly payments which they hold until you have enough money with which to settle your debt.  Most companies only work on one creditor at a time and when they have an amount sufficient on hand (minus their fees and costs, of course) they contact the credit card company and offer a settlement.  Settlement of credit card debt is not new.  Most credit card companies will take a settlement of the debt from anywhere to 50% to 75% of the total balance, provided they receive certified funds within 72 hours.  Consumers can do this without the aid of an intermediary who claim they are “qualified” debt settlement officers.  The truth is that the representatives possess no special training, expertise or qualifications to settle the debt and do not hold special influence over the credit card company.  They lead people to believe that they possess greater skills than you do to settle the debt, when in actuality, you can put money back in an interest bearing savings account and, when you have enough, settle with the company yourself.  But wait, the debt settlement companies offer a “legal” way to settle the debt.  Are there actually any illegal ways to settle the debt?  Why would it not be legal if you settled the debt on your own?

Sometimes their advice can end up damaging your credit report and leaving you in a worse financial position that when you started.  Oftentimes, the debt settlement company will advise you to stop paying on the debts while you are in their program.  Depending on the amount of debt you have and the amount of money needed to settle the debt, you may go for many months without making a payment on the debt.  The problem is that every late payment or missed payment is reported to the credit reporting agencies by the credit card company.  This will lower your credit score not improve it.  Furthermore, the debt settlement company offers you no legal protection from the credit card company suing you, getting a judgement and then garnishing your wages.

Let’s say the company is successful in settlement of the credit card debt.  What you may not know is that you could end up paying taxes on the amount of debt forgiven.  The Internal Revenue Service considers forgiveness of debt income.  That means that the credit card company may send you a 1099 at the end of the year and you will have to report any amount forgiven as income on your taxes.  As an example, if you have a $10,000 Visa debt and you settle for $6,000, you may have to pay taxes on the $4,000 in debt which Visa forgave.  That is true no matter who settles the debt.

To be fair, not all debt settlement companies are bad.  It is important, however, not to be manipulated into thinking you need their expertise for a remedy that potentially could make your credit score worse.

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