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Debt Settlement Companies: Friend or Foe?

September 9, 2009 by Silicon Valley Blogger

These days, lots of people are swimming in debt with nowhere to turn, no access to credit, and no liquidity, with their credit scores shot… and they’re wondering what to do next. Someone I know who is in this predicament just recently asked me for some input. I told them that there are various paths to the same end: to get rid of your debt or to reduce it to some extent. I’ve discussed many solutions here, mostly conservative ones that I explore in these articles:

• Get Rid of Your Debt With These Debt Defying Strategies
• How To Get Out of Debt With A Debt Repayment Plan
• Debt Elimination Tips: How To Reduce Debt
• How To Pay Off Credit Card Debt

Now there are several more radical ways and paths to choose to get to a debt free end. Are they worth investigating at all? Aside from do-it-yourself debt reduction methods that involve belt tightening and budgeting, there are methods such as debt counseling or management, debt consolidation and finally debt settlement, which are strategies that people have tried out when things got tough.

Image from DrDriving.org

Different Debt Reduction Strategies Have Their Costs

While there are many options here for anyone who wants to wipe away their debts, all these options have their costs. If you do it yourself by living frugally and making sacrifices, you’ll get the best rewards by learning better financial habits, but it may not be easy until you get into the habit of living with a new fiscal diet. If you involve others — by inviting advisors, third party agents or companies in the picture — the cost is this: the dependence on someone else to resolve your problem (in many cases, it’s something you can work on yourself) and of course, the potentially big fees you’d have to fork out for this help. Also, there’s the risk that some of these companies are going to give you minimal help for the money you pay; note that many consumers end up not making much headway with their debt problems when they end up signing with the wrong “professionals”.

Debt Settlement Companies: Friend or Foe? Some Pros and Cons

I read in a few publications that debt settlement is not really right for most people — it’s considered a “niche solution” for those heavily in debt and may be best for those who are already contemplating bankruptcy as a way out (check here to find out if you should start worrying about your debt load). I compiled some pros and cons to shed light on this particular debt reduction solution:

Debt Settlement Pros
Settling your debt is one way to make it all go away. If you’re so sick of your debt, are ready to move on, and are willing to face the costs involved, then this could be a solution. After all, your creditors would prefer that you give them something rather than nothing, so they’re likely to work out an arrangement with you. The positives:

• You’ll be debt free within a few years so you can focus on rebuilding your credit.
• You’ll probably be on the hook for much less than what you really owe (perhaps up to 50% or 60% less).
• You may be able to negotiate with and convince some creditors to go easy on the impact on your FICO credit score.
• The debt collectors will soon get off your back.
• You can finally reset your financial life.

Debt Settlement Cons
For the peace of mind that comes with releasing yourself from the weight of debt, there are of course the tradeoffs. And there are many — just check out the downside:

• You’ll have to pay debt settlement companies an upfront fee and possible recurring monthly fees to get the deed done.
• Your credit will take a hit when you “pay by settlement”, as this will appear on your credit report. If you already have bad credit, then this will be less of an issue.
• You may end up paying less to your creditor (who’ll agree to settle for less on your debt), but you’ll also end up paying a portion of your debts to your settlement company.
• Some creditors won’t work with debt settlement companies and may even treat you more harshly if you use such third party services.
• The debt you settle will trigger a tax: forgiven debt that exceeds $600 becomes taxable income! If you’re so deep in the hole, the tax you end up owing may put you in even bigger trouble.
• Debt settlement companies are only allowed to operate in certain states, and many of them are questionable.

After all this, I can only conclude that trying to settle your debts isn’t as easy as it sounds. You’d have to see if you belong to that rather small section of the population that will benefit from this process. But it’s pretty much like choosing the best of many weak options: if you’re in this bind, there really aren’t any attractive solutions left, unfortunately.

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