Debt settlement companies promise to “reduce debt up to 70 percent,” “negotiate with creditors,” and “help avoid bankruptcy.” Their promises sound too good to be true. The truth is that while debt settlement agencies sometimes accomplish what they promise, it comes with a price.

Debt settlement is a form of debt arbitration. Debt settlement agencies negotiate with creditors to reduce the amount of the total debt a client is required to pay back. Once involved in a settlement program, clients are often advised to halt all payments to creditors and to cease all contact with creditors. The agreement with the debt settler will require that your monthly payments be sent to the settler to be held until there is enough “on account” to begin settlement activity. This action will cause your creditors to:

• Raise interest rates to penalty levels due to missed payments
• Charge fees for late or missed payments and over-limit fees as the balance grows
• Increase collection activity from letters and calls to involvement of collection agencies, attorneys and the courts, increasing costs
• Garnish wages once they have obtained a judgment

Debt settlement agency wait to begin negotiation until they collect enough monthly payments from the client to cover both their fee and the full amount needed in order to settle the first debt. It could take months until the first contact is made. While the client pays the settlement company, the creditors continue the collection cycle up to and including garnishment procedures. Account balances continue to grow due to interest and fees during this time. A $1000 balance could turn into a $1600 balance in six months with no payments when interest accrues at $24 per month and late fees are $38 and over-limit fees are another $38. A 50% settlement obtained on the $1600 balance would be $800. When the settler’s fee is added in there is not much savings in the end.

The negotiated debt is listed on credit reports as “settled” instead of “paid in full”. This listing will remain, often showing the balance still due, for seven years from the settlement date. This notation severely hampers the ability to obtain credit. Banks are not comfortable lending when there is a history of less than full payments. If the settled debt is greater then $600, the IRS considers this amount income and requires the creditor to report it as such. A 1099 form will be sent by the creditor to the IRS and the client to be included with that year’s tax return so that the income can be taxed. This can create a tax liability and in the example above it would be at least an additional $120.

Currently, there is no national regulation of the debt settlement industry. Regulation is on a state-by-state basis. However, the federal government is now turning its attention to the debt settlement industry. The Federal Trade Commission held a workshop on September 25, 2008 to explore the recent rapid growth of for-profit debt settlement agencies. Travis Plunkett, Legislative Director of the Consumer Federation of America reported during the workshop that “1.4 percent of debt settlement customers successfully complete the program and settle their debts. Forty-three percent of their clients canceled the program after incurring fees of 64 percent of the amount remitted.”

For a small percentage of debtors whose credit is already severely damaged and have access at the start of the program to a sum of money reasonably large enough to work out settlements (such as a damage award from an accident or an inheritance), debt settlement is a viable option. To learn more about the debt settlement industry please join us at the Client Advisory Meeting on April 14, 2009 from 6:30-7:30 pm Central Time. We will be discussing this topic and any other questions or concerns pertaining to your experience with Credit Advisors. You can attend in person at any of our three locations in, Omaha, Neb., Scottsdale, Ariz., and Tacoma, Wash., or you can call our toll free conference line at 1-866-285-7780 code 4425358.