Know debt settlement companies' full cost

You will trash your credit and may owe a larger tax bill


Dear Credit Smart,
I am $45,000 in credit card debt. I spoke with a debt relief agency and they advised me to enroll in their debt settlement program where they will charge 35 percent of the amount that I enroll. They want me to stop paying my bills and have the credit card companies prove that I owe that debt and if they can’t prove I owe the debt I won’t have to pay. Have you heard of these programs and are they successful? – Danny


Dear Danny,
Debt settlement is certainly an option that has been around for some time and one that has been successful for some consumers. However, like almost all options, there are pros and cons, which must be carefully weighed before signing up for a program.

The main reason settling a debt is so attractive is that the monthly payments that are required are usually substantially less than what a consumer is paying to their creditors. In addition, the overall repayment is less. From a simple dollars and cents calculation, you are looking at paying fees of $15,750 if you enroll the entire amount. This is obviously less than $45,000, but you will probably have to pay at least half of that amount to your creditors to settle, which would be $22,500. This means that once you pay the fees and the settlement, you will end up paying $38,250, resulting in $6,750 savings. While that is not an insignificant amount of savings, let’s talk about the other costs you may face.

Because the company wants you to quit paying your creditors, your credit score is going to take a beating. Paying your bills on time is the No. 1 factor in credit scoring. Your accounts will go into collections, which will lower your score further. These marks will stay on your credit report for seven years and will make it very difficult for you to obtain credit if you need it during that time.

You should also know that your credit score and reports are used by other entities even if you don’t plan to apply for any new credit. For instance, car insurance companies (except in Massachusetts, Hawaii and California) may review your score to set your rate, and it is standard practice for landlords to check credit reports. If at the end of it all your accounts are settled for less than you owe, any amount that is forgiven will have tax consequences. If $22,500 is forgiven, that forgiven debt will be reported to the IRS as taxable income. In addition, you will receive phone calls and letters from your creditors looking for payment since up to now you have probably been paying them on a somewhat regular basis.

As for proving you don’t owe the debt that may be easier said than done. You certainly have the right to dispute your bills and the credit card companies know this and are prepared to prove the debt. You may delay the process by disputing, but I don’t believe you will have much success erasing your debt this way. This is especially true if you have indeed been paying your bills up to now.

 I know that you are looking for a way out of this debt and I want you to know that you do have other options. My suggestion is that you call a certified, nonprofit credit counselor from the National Foundation for Credit Counseling. A counselor will work with you to help you find the right solution. After the counselor has reviewed your financial solution, he or she will go over all of the options available to you, including debt settlement. Initial counseling is always free and you are never under any obligation to take their advice.

You need to explore all of your options before you make a decision that is going to impact you for several years.

Remember to always use your credit smarts!

See related: How “jamming” cleans your credit report, but only temorarily

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Updated: 01-19-2018