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As U.S. consumer debt balloons to an all-time high, people are looking for solutions. As a way out, some consumers have turned to debt settlement companies, which claim to help people gain control of their finances when they’ve fallen behind on payments. But the tactics often used by these companies can put consumers in greater debt and harm their credit scores. If you’ve considered a debt settlement company, here’s what you should know about the process and its risks.
Debt settlement companies are sometimes touted as an alternative to bankruptcy. Also called “debt relief” or “debt adjusting” companies, these for-profit companies promise to negotiate with your creditors to reduce your debt.
When you contact a debt settlement company, they’ll generally ask for the names of your creditors and the amounts that you owe. Then, they’ll give you an estimate for a new, lower monthly payment. They’ll also typically advise you to stop paying your creditors and to send payments to an escrow-like account, which you might have to pay fees on. Next, the debt settlement company will contact your creditors to try to get them to accept a smaller amount and write off the rest as bad debt.
This process presents several risks to you, starting with the debt settlement company telling you to stop making payments directly to your creditors.
First of all, your credit score is likely to take a hit. Because you aren’t paying your bills, missed payments will be reported to credit agencies which will likely have a negative impact on your credit score. During this time, you’ll likely also rack up late fees, interest and other penalties. Debt settlement companies use this tactic as a way to make creditors believe that, if they don’t accept the lower amount, they might get nothing.
There’s a chance the debt settlement company won’t be able to settle all of your debt. Some of your creditors could refuse to work with the debt settlement company or may not agree to reduce the debt. Your creditor may even send your debt to a collection agency or file a lawsuit against you.
Even if the debt settlement company is able to settle all or most of your debt, the fees, interest, penalties and hit to your credit score might not be worthwhile. According to the U.S. Consumer Financial Protection Bureau, debt settlement may leave you in even deeper debt than before you tried to settle.
There are alternatives to working with debt settlement companies. You can contact your creditors directly and try negotiating. If, so far, you’ve had a good track record, you might be able to negotiate a different payment date or to skip a payment.
You could also try approaching a credit counseling agency. These agencies are usually nonprofit organizations and can draft a debt management plan for you. They may also be able to negotiate with your creditors, but instead of asking you to neglect making payments the way debt settlement companies may do, you make monthly payments to the credit counseling agency, which then sends that payment to your creditors. Learn more about credit counseling agencies and other alternatives here.