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Debt Settlement Company Pitfalls

Credit Wise (featured column)
by Jennifer Wallis

Lately, we have been noticing an interesting trend. We are seeing quite a few clients coming to our non-profit credit counseling agency for help that had signed up with a debt settlement company. They want out of their debt settlement contracts and want to see what we can do to help them escape.

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You’ve probably heard of debt settlement companies, whether you know it or not. If you have heard the radio or TV commercials promising to get you out of debt for 40% of what you owe, that is a debt settlement company. Many debt laden consumers hear these ads and feel like their prayers have been answered. Many people just want the debt to go away so paying less than the full amount sounds like a great option. It is critical to understand exactly what the consequences could be, if you are considering a debt settlement company.

First, let me explain how most of them work. If you sign up with a debt settlement company, they will work out a payment plan with you. They charge an up-front fee and then a percentage of the debt they settle for you. Many plans last for 36 months. They usually tell you to stop paying your creditors entirely and advise you to pay them instead. Approximately, the first 13 payments pay their fee. No money will be sent to your creditors. After that, your payments go into a trust account. They accumulate your funds while trying to negotiate settlements with your creditors. Remember, your creditors have not received any money since you began the debt settlement plan 13 months prior. Often, creditors are willing to accept some of what you owe them. Since you have not paid anything in over a year, it looks like they will not receive anything. If they do negotiate a settlement with one of your creditors, they will deduct it from your trust account and charge a percentage as their fee. This continues until all of your creditors have settled and you are out of debt.

If you are thinking that this sounds like a great idea, please keep reading. There are a few more things to consider before you decide that debt settlement is the way to go.

Here are some of the trends we see consumers dealing with every day:

Your credit will suffer:  

You will simply stop paying your creditors on a debt settlement plan. The idea is to withhold payments until creditors get desperate enough to think you are never paying anything then, they will accept less than you owe. In the mean time, your credit will show 30 days, 60 days, 90 days, 120 days late and then some creditors will charge off your accounts. Your credit score will plummet. This pattern will show any potential lender that you don’t repay your debts. Everything you do will stay on your credit report for 7 years.

Your creditors may sue you: 

There is nothing stopping a creditor from suing you if you stop paying. I have had numerous local creditors tell me that they immediately file suit if they see that one of their clients is using a debt settlement company. One client that we recently counseled had his car repossessed. Numerous others have ended up in court. While some creditors may only send you to collections, many others are fighting back with lawsuits to collect the money that is owed to them. If they sue, you may also have attorney fees to contend with.

You may not be saving that much: 

One of the advertising messages for debt settlement companies is that you don’t have to pay back all of what you owe. If you are considering using a debt settlement company, it is important to take into account what the final cost will be. Remember to add in all of the debt settlement company fees that you will have to pay. Also, your creditors will still charge you late fees (about $40 per month each for a late fee and over the limit fee) and interest (which will usually go up to 28% or more after you default) at least during the first 150 days after you stop paying. So, you will need to add about 6 months of interest and fees to your balance before they get to the point where they may settle.

It’s all there in the contract:  

Unfortunately when you’re in debt, you just want to get out. The stress you are feeling seems unbearable. You just want it to go away so you may sign your name on the dotted line without thinking about the repercussions of every single item in the contract. You may not stop to think about how you will feel 6 months down the road. Most debt settlement contracts that I have seen tell you everything that I am telling you now. People sign them anyway because they just want out of that situation. By the time many people realize what they have done to their credit and creditors, they want to change it. There are other options but too often the fees that have been paid are non-refundable. The damage that has been done to the credit is irreversible. The only thing that can improve your credit is time and responsible bill payment.

You may have to sign a Power of Attorney: 

A Power of Attorney is a legal document that allows a business or person to act on your behalf. They are typically used when a person is incapacitated (or unavailable such as deployed out of the country) and wants to give another trusted family member or friend authority to make decisions regarding their finances. A debt settlement company may ask you to sign one so that they can negotiate on your behalf. The other thing that this accomplishes is to ban your creditors from contacting you, thus stopping the collection calls and letters. While this may seem like a welcome reprieve, it is still scary to think of authorizing a company with which you have had little contact, to legally act on your behalf.

When you are deciding how to resolve your debt issues, it is important to look at every option, read every contract in full, and don’t sign anything you are unsure about. If you don’t quite understand it, ask a trusted friend or family member to look over the contract with you. While it is true that a debt settlement company may be able to reduce the amount that you pay back, it really may not be worth it. Debt settlement is not for the faint of heart. Make sure that you are at peace with the consequences of your decision because they may be following you around for a while.

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Copyright © 2007 by Jennifer Wallis. All rights reserved.

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