How Debt Settlement Can Impact Your Financial Future

            Americans owe $2.5 trillion in consumer debt, excluding mortgages. The average American with a credit file is responsible for more than $10,000 in credit card debt. Where to turn for help is the big question? Be careful where you go, as you could make your situation worse.

            Here’s what you need to know about debt settlement.

             How it works

             The basic premise of debt settlement is that you can work out a payment plan with creditors to avoid bankruptcy and settle outstanding debt, says Benjamin Yrungaray, a bankruptcy and debt settlement attorney with First Source Law, (www.firstsourcelaw.com).

            Most debt settlement companies set up a monthly budget for the household and then establish a monthly payment the client can make into a trust account dedicated to settling debt. Once enough payments accrue to start settling the debt, the company then begins debt settlement negotiations with creditors to settle the account for a percentage of the original debt. Depending on the nature of the debt and the debtor, a debt settlement company can typically settle for 30-40 percent of the original debt, explains Yrungaray.

            What’s the chief advantage? “You can settle a debt for a fraction of the original debt, despite being legally obligated for the whole amount. For many people, this means avoiding bankruptcy,” he adds.

             Is it for you?

             Debt settlement can be helpful for many, not all Americans who are facing unmanageable levels of personal debt, explains Andrew Housser, CEO of Freedom Debt Relief in a prepared statement.

            Who’s the best candidate for this kind of debt relief? “If you are significantly behind on your debts and see little chance of catching up, you may want to consider debt settlement as an alternative to bankruptcy,” says Scott Crawford, founder of DebtGoal.

            Howard Dvorkin, founder Consolidated Credit Counseling Services is a bit more blunt, “If you haven’t paid your bills in six months, don’t care about your credit rating, don’t care if you get sued or not, and have no plans to buy a home, that’s who’s a good candidate.”

            In other words, it’s mostly an option of last resort before bankruptcy.

             Debt settlement 101

             What’s the issue with debt settlement? While there are legitimate folks in the space, like elsewhere, there can be some less that ideal operators and even with good companies, sometimes people just don’t understand how settlement companies work, and what it will mean for you. Simply put, it’s not so simple.

            First off, check out the company. Do your research and check with the Better Business Bureau. Go to The Association of Independent Consumer Credit Counseling Agencies website (www.aiccca.org) and search for an agency that is able to work in your state, advises Neil Ellington, executive vice president of the non-profit CESI Debt Solutions.

            When you start a settlement program, most will ask that you take the money you were paying lenders and pay their fees instead, which tends to be around 15-20 percent of your beginning balances, explains Crawford. You don’t get this back even if you don’t complete the program, which is why settlement offers have been banned in several states, he adds.

            Things get worse before they get better. During the time you quit paying your lenders, you’ll get collections calls and late fees and finance charges will mount up. Things are going to look ugly, says Crawford.

            Your credit will tank. Maybe this matters, maybe it doesn’t, but settlement requires that lenders have such a low opinion of the likelihood that you’ll pay back your debts that they’re willing to settle for pennies on the dollar. When you quit making payments to creditors, your credit score will fall. The negative impact on your credit will stay in your file for seven years, says Crawford.

            What people don’t realize is that the money that they send to the debt settlement company for about the first four months is going to the debt settlement company, so perhaps in month five the money starts building toward what will be given to creditors. It can take up to 8-12 months before your creditor gets a dime. “This destroys your credit because you’re not paying your creditors for that length of time and debt settlement companies often tell you not to contact your creditors, so you just go dark on them,” says Dvorkin. You could end up getting sued by your creditors.

              Discipline is required

              Part of the reason settlement is under attack as a solution is because very few people actually complete the programs. One state investigation of a settlement provider found that 89 percent of customers left with more debt than when they started, despite the fact that they had paid thousands in up-front fees, says Crawford.

             If you don’t finish the program, all your debts will still be outstanding against you and they will have compounded with finance charges and late fees. Generally, the odds are against you finishing unless you’re incredibly disciplined. “And let’s face it, if you’re considering debt settlement, financial discipline may not be your strong suit,” he adds.

             Ask tough questions

             If you decide that you are going to use a debt settlement company here’s some of what you should be asking/doing:  get a written description of the services they provided, written fee structure, explanation of how the program will impact your credit file, what will happen if you have current accounts, is the company licensed to provide services in your state, how long the program will take to start and how long to complete, says Ellington.

            Lastly, if you’re even considering a debt settlement company, face the reality that you need to make changes to get back on track. It’s time for a serious self-chat. Figure out a better plan so that you’re never in this situation again.