When is Debt Settlement a Good Idea?

Debt settlement services are certainly not for everyone, and the industry is still very unregulated, but it is worth considering in some cases. If you decide to turn to debt reduction services, make sure you exercise extreme caution and do your homework before working with a company, or even a debt settlement attorney, to avoid being taken advantage of.

Settlement allows you to pay less than your balance by negotiating with your creditors for a smaller amount to satisfy the total debt. While this may sound like a great solution to help you overcome a mountain of debt, there are serious consequences. Debt settlement companies appeal to consumers who are very troubled by debt but wish to avoid bankruptcy at all costs - and all costs is right. Not only is this service very expensive, it will also do serious damage to your credit.

Potential dangers of debt settlement include:

• Fraud: There are some companies who offer debt settlement services who are no more than fly-by-night scams, taking huge upfront (and illegal!) upfront fees and disappearing. Other debt settlement companies are simply too inexperienced to effectively negotiate a deal, or even bother. Either way, your money is wasted at a time when you cannot afford the loss.

• Damage to your credit: Debt settlement companies will require you to stop paying your bills to build up a lump sum for settling, and to get leverage, but this comes at a cost. Your credit will be tanked, and the higher your score to begin with, the harder the hit. Successfully settling debts also hurts your credit.

• Lawsuits and wage garnishment: Creditors will often escalate their actions against you when you obtain debt reduction services from a company. This means they are quick to file a lawsuit when you default, which can lead to a lien against your property and wage garnishment. In many cases, creditors will immediately take legal action when they find out you're working with debt settlement companies.

• No regulation: The federal government does not regulate debt settlement companies and the few rules they have in place are largely ignored. Proceed at your own caution.

• Taxes on forgiven debt: The IRS will usually consider the difference between what you owe and what you settle for as taxable income. This means you may owe about $2,500 in taxes for every $10,000 that's forgiven.

• Cost. Debt settlement is very expensive, and some companies will charge 14-18% of the total balance that you want settled, while some will want a huge percentage of the amount they successfully settle.

• Time involved: Finally, debt settlement is not a fast process and the average debt settlement process is longer than two years.

When Does it Make Sense?

So, when does attempting to settle your debt actually make sense? If you can afford your debt but only if the amount is reduced, attempting to settle may be a good option. In general, settlements should be used if you can't qualify for Chapter 7 bankruptcy (or cannot afford to do so because of your job), if you accept that your credit will take a big hit and you understand that you may be on the hook for paying a lot in taxes and fees.

If you're thinking about turning to debt settlement, consider working with a debt settlement attorney versus a non-attorney company as they can represent you in court if your creditors sue you, and they will offer better leverage in dealing with your creditors.

Warning Signs of a Debt Settlement Scam

With millions of Americans facing hard times and unbearable amounts of debt, it comes as no surprise that debt settlement companies are everywhere, advertising that they can settle debt for pennies on the dollar, stop creditor calls and preserve your credit. Unfortunately, most of these companies make unreasonable or even illegal claims, and you can get yourself into even greater trouble by signing up for their services, left in the end with an even greater amount of debt and thousands gone in fees.

Before you consider debt reduction services, make sure you know the following warning signs of a scam. 

1. They claim they can dramatically reduce your debt

This is the primary claim associated with debt reduction services, of course, but it's a serious red flag if a debt settlement company claims they can and will do so. It's true that some of your creditors may be willing to reduce your balance, but this is an unrealistic claim and they cannot make any sort of guarantee.

2. They claim they will stop collection calls and prevent legal action

Be aware that debt settlement companies have absolutely no control over the debt collection practices of your creditors. This means they cannot stop collection calls, and they absolutely cannot prevent legal action against you. Unfortunately, many creditors are known to become more aggressive, not less, when they find out you are working with one of these companies. That means collections will start sooner, and you will be more likely to be sued in court. In this case, the company cannot help you.

3. They charge a high upfront fee

Did you know it is illegal for debt settlement services to be charged upfront? A debt settlement company must successfully settle at least one debt before charging you, so be aware of your rights. Also, a legitimate company bases fees on the amount you owe to your creditors and it's directly tied to their performance on your behalf. Don't agree to pay huge fees for a service you do not know you will even receive.

4. They tell you your credit will be unharmed

Do not trust any company that provides debt reduction services if they tell you your credit will not be affected. The truth is your score will be affected when a debt settlement company gets involved. You will most likely be told to stop paying your accounts to create incentive (which causes late payments on your credit), and even the successful settling of a debt is a red mark on your credit that remains for 7 years.

5. They tell you not to speak with creditors

Finally, be aware that this is only an attempt to keep you from knowing the real status of your accounts. This is not something a reputable company will do, and one of the many reasons you may be better off working with a debt settlement attorney who is bound by the law and works in your best interests.