“Get out of debt today!”
When finances are tight, the promises you hear in debt settlement ads sound appealing.
But is settling your credit card debts for less than you owe really that easy? Can anyone do it? And what are the consequences? Before you decide to try debt settlement, make sure you know the difference between common myths and the truth:
Myth No. 1: Anyone can get their credit card balance cut in half for any reason.
The truth: Legitimate debt settlement companies qualify clients, including asking for details about their hardship, says Tomás Gordon, CEO of Clear One Advantage, a debt settlement company.
Debt settlement is for consumers experiencing hardships such as a loss of a job or pay cut, a divorce, medical problems or, in some cases, debt that has simply spiraled out of control. “Maybe they’re borrowing from one credit card to pay the balance on another,” Gordon says.
Lenders want to make sure a consumer is having legitimate financial difficulty. “If they’re making $300,000 a year and just don’t feel like paying their bill anymore, that’s not going to be acceptable,” Gordon says.
Myth No. 2: I have to pay someone to help me settle my credit card debt.
The truth: “I proved that myth is not true,” says Kenny Golde, author of “The Do-It-Yourself Bailout.” Golde is a filmmaker whose partner became ill and passed away while they were making a movie. By the time the film was completed and it became apparent the film wasn’t selling in a timely manner, Golde was $250,000 in debt. He consulted with a bankruptcy attorney, who told him about debt settlement.
Golde had heard a lot of debt settlement companies are scams. He figured no one would work as hard on his behalf as he could. Besides, he says, “Here was a challenge, and I wanted to move forward and meet that challenge." Golde successfully negotiated his debts and saved nearly $150,000.
On the other hand, having an experienced negotiator on your side can help. “You call and try to negotiate a balance, and it’s like, ‘Get in line.’” A card company’s attitude may be, “Yeah, you and everybody else,” says Ken Clark, author of “The Complete Idiot’s Guide to Getting Out of Debt.”
Based on experience negotiating with creditors, debt settlement companies know what percentage of debt owed each creditor is likely to agree to, Gordon says. The pros also have more leverage with creditors due to their volume of business.
“It’s kind of like, you can change your own oil in your car, but that doesn’t mean you’re going to do it the right way,” Gordon says.
Myth No. 3: I have to pay upfront for debt settlement and the settlement company controls my money.
The truth: Not anymore. Debt settlement companies that market their services are banned from collecting advance fees from consumers before settling or reducing a consumer’s credit card or other unsecured debt, according to a Federal Trade Commission rule that took effect in October 2010. The rule also specifies that the consumers’ money set aside to pay debts be maintained in an account at an insured financial institution; that the consumer owns the funds and any interest accrued; that the debt settlement company does not own, control or have any affiliation with the company administering the account; and that the provider does not exchange any referral fees with the company administering the account, the FTC says. Also, consumers can withdraw from the debt relief service at any time without penalty and receive all unearned provider fees and savings within seven business days.
Myth No. 4: Debt settlement won’t hurt my credit score.
The truth: Debt settlement can hurt your credit score almost as much as bankruptcy.
Although asking for a settlement on your own won’t hurt your credit score, succeeding in getting a settlement – or skipping payments as some settlement companies advise – definitely will. “Defaults, settlements and similar events don’t affect your credit score until they are reported,” says R. Glen Ayers, attorney and former bankruptcy judge. “But of course these [defaults and settlements] are usually reported.”
Myth No. 5: Using a debt settlement company won’t cost much.
The truth: Debt settlement companies will charge you on a percentage basis, usually a portion of your total debt or of the amount forgiven. For example, Clear One Advantage charges a percentage of the total debt the consumer enrolls in the program.. However, the company doesn’t collect until it has made a settlement and the customer has approved it, Gordon says. A legitimate company should never charge upfront fees. “Not a one-time fee – nothing,” Gordon says.
Finally, debt settlement might cost you at tax time, too, because Uncle Sam may get a cut. The amount of debt that is forgiven by a lender is often taxable.
Myth No. 6: If I don’t settle, the debt stays forever.
The truth: There is a statute of limitations for collecting on debt. Many collectors, whether the issuer or a person or entity who has purchased old credit card debt, attempt to collect debt that is often time-barred – where the statute of limitations has run out, Ayers says. The statute of limitations laws vary from state to state, but if a debtor has not made a payment on an account for enough years, the debt is no longer enforceable in court.
Some companies buy old and time-barred credit card debt, and then send out letters trying to collect or, without actually trying to “collect,” offer to settle for, say, 10 percent, Ayers says. Some courts have ruled that these “non-collection” letters do not violate the Fair Debt Collection Practices Act, but the United States Court of Appeals for the Fifth Circuit has ruled that some actions can violate the FDCPA, he says.
The bottom line is these companies are essentially preying on consumers. “Paying off such debt, even at cents on the dollar, does little or nothing to repair bad credit,” Ayers says. “The debt had long since been written off and the partial repayment will never be reported to anyone, anyway.”
In addition to the legal obligation dying out, the credit damage will also sunset. Negative information on your credit report – such as a failure to pay – drops away after seven years.
Myth No. 7: Debt settlement and bankruptcy are my only options when I can’t pay.
The truth: You always have options. For example, if you lose your job, call your credit card company. It may allow forbearance. In other words, it may allow you to make smaller payments – or no payments at all – for a limited-time (you’ll still be charged interest, however).
If it’s time to get your finances under control, a nonprofit credit counseling organization can help you look at the big picture and see all your options, from downsizing to increasing your income, or managing your budget.
Each person’s situation is unique and there’s not a one-size-fits-all approach, Gordon says. For example, if a consumer has only one credit card and just needs a reduction in interest rate and a lower payment to take a little pressure off, credit counseling might be the way to go. If a consumer lost a job and has zero income, debt settlement might not be doable because they have to be able to afford the settlement payment, he says. And, “In some cases, bankruptcy might be a good option,” he says.
However, for some consumers, debt settlement may be the best choice. Consumers can save as much as $3 for every dollar they pay in fees, according to Gordon. “That is significant,” Gordon says.
Myth No. 8: When negotiations are done, I’ll be out of debt.
The truth: Some debts just don’t qualify for debt settlement, including student loans, taxes owed, child support and alimony.
Also, in most cases, you can’t settle secured debt like an auto or home loan. However, there may be exceptions to that rule. For example, one debt settlement company, National Debt Relief, sometimes can settle secured debt when the item securing the loan has been repossessed or no longer has value. Examples include a totaled car or a second mortgage on a foreclosed home.
In short, if a debt settlement promise seems too good to be true, it probably is. Debt settlement won’t provide magical solutions to all your debt problems, but it can be a viable option in some cases.