What’s the Deal With Those Debt Settlement Services?

I’m fascinated by bad or corny television commercials.  Some are downright charming.  I’m mesmerized by the underwater-motion and creepy interaction common to pharmaceutical commercials.  And who hasn’t been jarred from a peaceful couch nap by shouted announcements of Big Big RV sales or drag races (“Sunday! Sunday! Sunday!”)?  Naturally I’m intrigued by the seemingly endless parade of “debt settlement” offers.

Surely you’ve seen these commercials too.  They might begin with ominous music and actors in crisis, similar to many tax relief commercials.  Or they might open with some good news: “As a result of today’s economic crisis, banks are willing to accept significantly less than you owe!”  Either way, they want to let you know: “If you owe more than $10,000 in credit card debt, our specialists will show you how you can lower your monthly payments, reduce or eliminate your debt, and get your life back on track.” A “real person” will then tell you: “I cut my payments in half” or “I got an affordable payment of $400 per month, got out of debt in two years and only paid 40% of what I owed!” 

How does this work exactly?  According to the commercials, the debt settlement services “work directly with credit card companies” and can “help you negotiate.”  It’s as if these companies have secret knowledge of magic words that will force credit card companies to offer settlement at a deep discount.  

Alas, there are no magic words.  In practice, it often works like this: The debt settlement service will tell you not to make further payments on your credit cards and, instead, send your money to the debt settlement service.  The idea, apparently, is that once the debt settlement service is holding enough of your money, it can contact your creditors and use this leverage to try to negotiate. 

By now, you have probably spotted some flaws:

• You already have the ability to negotiate with your creditors directly.  You don’t need to pay a third party to do this. 

• Your creditors are usually under no obligation to agree to any compromise, either from you or from anyone you hire. 

• While the debt settlement service is stockpiling your money, your debt continues to grow as interest and late charges are applied, and you may continue to receive harassing communications from creditors and collection agencies.  During this time creditors are free to sue you, garnish your wages, or seize your property.  In other words, this can be a major gamble.  If the negotiations are not successful, you will wind up even deeper in debt than when you began the process. 

• Many times, debt settlement services do nothing for you, and you may never recover the money you send them.  

• Using a debt settlement service will not avoid potentially negative credit history.

• Even if a debt settlement service successfully negotiates a reduction with one creditor, your other creditors are not obligated to follow suit, so it may not fully resolve your financial difficulties. 

• Debt forgiveness outside of bankruptcy can sometimes result in tax consequences.

• The fees charged have not been disclosed.    

-      More information about debt settlement services is available from the Consumer Financial Protection Bureau here.  The CFPB recently settled a lawsuit with a major debt settlement service, requiring payment of $20 million in restitution and $5 million in civil penalties.

Debt settlement commercials frequently take pot-shots at the bankruptcy system.  They say they offer “a solution besides bankruptcy” or want to help you “avoid the possibility of bankruptcy.”  The implication is that bankruptcy will be a regrettable life decision, like getting a face tattoo or a law degree.  The decision to file bankruptcy should be made carefully, with the advice of an experienced attorney.  In many cases, bankruptcy relief will have advantages over negotiating with individual creditors using a debt settlement service:

• As soon as you file bankruptcy, there is an “automatic stay” that applies to every creditor.  The automatic stay bars any future attempts to collect the debt.  This means you can’t be sued or garnished, and creditors cannot contact you to request payments or otherwise harass you.  Interest and late charges stop accruing on “unsecured debt” like credit cards.

• A bankruptcy discharge applies to all of your creditors, whether or not they agree.  Exceptions apply for certain types of debt, such as student loans, taxes, and child support, but garden-variety creditors must specifically object to discharge and prove an exception, such as fraud applies; if not, the debt will be wiped out by a bankruptcy discharge. 

• A discharge order issued by a bankruptcy court is clear and simple proof that you no longer owe the debts listed in your bankruptcy petition.  This avoids the need to document and enforce settlements with individual creditors that may not be honored if the debt is later sold to a “debt buyer.”

• Many people who file bankruptcy do not need to pay anything to their creditors.  As one example, a “no asset” Chapter 7 bankruptcy case can be concluded in about four months.  The amount you pay your creditors in bankruptcy is determined by several factors, including household income and the amount of equity in property. 

• Fees that you pay to a bankruptcy attorney must be fully explained to you in advance, and disclosed to the bankruptcy court. 

• Discharge of debt in bankruptcy is not treated as “debt forgiveness” income for tax purposes.  

If you are dealing with financial hardship, plan your solution carefully.  Before engaging anyone to assist you, do your research to make sure you are about to hire a reputable and competent professional.  No 30-second television commercial will ever be an adequate substitute for this!  Whoever you hire should be able to clearly answer your questions and explain the process and the fees and charges involved.  Trust your instincts.  You should feel comfortable with whoever is helping you.  If something doesn’t seem right to you…reach for the controller and see what else is on.

The 7thirteen is a blog written by Jeff Narmore, focusing on consumer bankruptcy issues.  Visit my website at narmorelawoffice.com.

Narmore Law Office LLC is a debt relief agency and helps people file for relief under the Bankruptcy Code.