The following is a guest post from reader Daniel Gershburg, Esq., who writes about the inner workings of debt settlement agencies. Daniel is a bankruptcy attorney in New York and New Jersey.
Over the past several years, our economy has gone into the tank. Rampant unemployment, underemployment, in fact a near collapse of the financial system have completely reshaped our financial lives. Millions of Americans are in credit card debt over their heads and can’t afford to pay even the minimums. And the creditors have, in many cases, several cut credit lines and hiked our interest rates. In a situation like this, a debtor basically has three options.
The first option is to file for Bankruptcy. While I think it’s the soundest option, both with regards to ones credit and future financial well being, I’m also a Bankruptcy attorney, so of course I feel that way.
The second option is to try and settle with credit card companies and bring down your interest and pay off your debt….good luck with that. They’re about as interested in settling with you now as you are in buying an investment property in Las Vegas.
The third option, and the option I’d like to discuss in depth here, is employing a Debt Settlement company to try and settle the debt for you. This not only, in my opinion, is the worst option of the lot, but based on what these companies claim, may border on fraud. Literally, fraud. Here’s why:
The promise of bailouts
Turn on the radio or the TV and you’ll hear absolute nonsense about how debt settlement companies can reduce the amount you pay to your creditors by up to 80%. One, called the Obama Credit Card Relief Program (I’m serious) promises to Cut Up To 70% Off Credit Card Debts under “Bailout Relief”. Again, absurd. The claims that many of them make aren’t even mathematically feasible based on most people’s budgets.
Many of these companies also make claims that they are Not for Profit companies. You hear that and you think of people planting trees, feeding the homeless in soup kitchens, and you begin to almost subconsciously trust these companies. The IRS did a little research into these feel good claims. Here’s what they found:
Over the past two years, the IRS has been auditing 63 credit counseling agencies, representing more than half of the revenue in the industry. To date, the audits of 41 organizations, representing more than 40 percent of the revenue in the industry, have been completed. All of the completed audits have resulted in revocation, proposed revocation or other termination of tax-exempt status. [Source: IRS.gov]
How do debt settlement companies really work?
Our offices receives irate phone calls on a weekly basis from trusting individuals who are in over their heads with debt, that have paid and used these debt settlement companies. They typically paid 10-20% of their debt to the debt settlement company as their upfront fee. Then there are a myriad of other fees, including “account maintenance fees” of up to several hundred dollars a month with no real reason.
Here is a more detailed example. You owe $40,000 in credit card debt to 5 different credit cards. Each card has a different balance. You sign up with Debt Settlement Company #1. They take their $4,000-$8,000 initial fee when you begin (sometimes this fee is payable over one year). They’re also likely charging you those account maintenance fees. The debt settlement company will then tell you to stop paying your cards. So instead of paying an interest rate of, lets say 10% or 15%, you’ve now defaulted and your balance is now growing at a rate of 25-30%. Now you’re out 4,000-$8,000, your credit card balances are growing at a 30% clip, and angry people are calling you and your loved ones demanding money on an almost hourly (I’m not exaggerating) basis.
The Debt Settlement Company will now tell you that you need to save money each month and put that money into a segregated escrow account, which the debt settlement company conveniently maintains for you. And when they think you have enough to settle with a creditor, there is absolutely no guarantee that the proposes settlement is accepted. Meanwhile, you’re paying account maintenance fees during this saving period. If they ever do settle, you may also owe the debt settlement company money based on the amount they settled for. And then you would have to start the process again for the next creditor.
The more important question that the debt settlement company is typically never able to answer is: If you didn’t have the money to pay your minimums, how in the world are you saving enough money to settle with these creditors? Ever wonder why these companies typically don’t take cases unless you owe $10,000 or more? Because if they did, the fees would be so exorbitant as compared to any settlement that they could get you, that it wouldn’t make any mathematical sense whatsoever to even begin in the first place.
In addition, many of these companies leave out the following: Say for instance owe American Express $10,000 and you settle for $2,000. American Express can issue you a 1099 for the $8,000 you saved by “settling”. In other words you may owe taxes to the IRS based on the difference in the amount you owed and settled for.
At the end of the day, in my opinion, you are FAR FAR worse off ever paying these people a penny of your money than doing this on your own or filing for Bankruptcy for literally a fraction of the cost. This is like having been shot 6 times and having one band-aid, and you try to put the band-aid on one wound, and then move it to the other. It’s simply not going to work. You’re not dealing with the underlying problem here.
Here are some more sobering facts about these companies. The National Consumer Council, which was shut down by the Federal Trade Commission in 2004 on accusations of falsely claiming nonprofit status, had their records reviewed. The company’s court records show that only 1.4% of the consumers who signed up for the program ever completed it. 1.4%!!!
I understand the apprehension some of you may have. I am a Bankruptcy attorney in New York. I make money if people file for Bankruptcy instead of attempting to go through debt settlement. The simple fact is many of my clients have attempted working with a debt settlement company before deciding to file Bankruptcy, losing thousands of dollars in the process. The point is this. If you’re in credit card debt, you’re far from alone. And there are various ways to deal with the debt that don’t involve wasting countless thousands that you don’t even have, and more importantly, time and stress. Debt Settlement, to me, is not even an option.