Why You Shouldn’t Use Debt Settlement Agencies

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.

Recap

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.

Comments

  1. Why can’t people get this into their heads: If something sounds too good to be true, then it invariably is!

  2. You’re spot on about the Debt Settlement companies, I know of many cases where the debtor was just cheated out of their money.
    However, I believe people can settle with the credit card companies and bankrupcy should be a last resort. I was able to settle for about 40% of the amount I owed, and I am not a professional.

  3. I’m not sure I follow: If you’re going to declare bankruptcy anyway, and lose everything in the process, why not try any other possible avenue first, even if it costs a lot and may not work? You have nothing to lose, correct? If it somehow works, you’re in better shape than if you filed bankruptcy, in terms of your credit rating. If it doesn’t work, you then file for bankruptcy, and the thousands that you sent to the debt settlement company are irrelevant since you would lose them anyway.

  4. I’d say the biggest reaosn is that you can do your own negotiation (if you choose to go that route) on your own, and for free.

  5. “…why not try any other possible avenue first, even if it costs a lot and may not work? You have nothing to lose, correct? If it somehow works, you’re in better shape than if you filed bankruptcy, in terms of your credit rating. ”

    NO, you will not be in “better shape, in terms of your credit rating.” The creditor will be writing-off the loss and will report this. You will get the R9/I9 on your credit report. Bankruptcy is cheaper and faster.

  6. When it comes to paying off your debt there are several options to consider as you mention in this post. I agree there are some really unscrupulous providers that consumers should be protected from. In our experience we have found that for consumers who cannot afford a debt management plan and either do not qualify or do not want to file for bankruptcy, that debt settlement offers them a desirable alternative.

    As with any financial decision, it is important to explore the benefits and challenges before enrolling in any type of Debt relief plan. Participating in a Debt Management plan or working things out with creditors would have the least impact to a consumers credit; but if it it not affordable or feasible for a cosumer to do so, debt settlement is an alternative to before taking the leap to file bankruptcy.

    Debt settlement is not easy, nor a quick fix. It can take years to complete, and creditors will likely escalate their collection activities. The benefit is the ability to pay off debt for a lesser amount, and save thousands of dollars in interest and finance charges.

    The challenge is to match consumers with a legitimate company that they can trust who will look at their entire financial picture and who will match them with the “best” plan for their unique situation which may or may not be debt management, settlement, or bankruptcy rather than the only solution they offer.

    Unfortunately, while the FTC regulations help to weed out the bad apples it is really up to the consumer to do research before they sign up with any provider. While attempting to handle settlement on their own is certainly an option, one caution is to ensure that they receive a legal contract that binds the creditor to the agreement as we have seen creditors go back on the deal and continue to attempt to collect the remaining balance.

    For your readers who do want professional assistance I would recommend that they review this post with Questions to Ask a Debt Relief Provider http://c1c.bz/23i to ensure that they are working with a legitimate company that has their best interests in mind.

    There was also a great article on Yahoo Finance http://c1c.bz/o0y
    that discusses the new guidelines that may help you with your future posts on the subject. We would be happy to provide background information on the industry and what is happening as we have been very actively involved in supporting legislation to protect consumers. If we can help in any way please let me know.

    Suzanne – Debt Relief Expert – CareOne Services, Inc.

  7. Being a fellow NY Attorney, I’d love to hear Daniel’s opinion on the arbage debt collection LAW FIRMS we have in NY?

  8. These companies are a total scam.

    Claiming President Obama has anything to do with it is just a lie. There is no government bailout for credit cards.

  9. From the Rowley article, it seems like much is in agreement:

    “In debt settlement programs, upfront fees previously ran as high as 20 percent of the client’s debt. Some companies required clients to deposit a monthly payment into a designated account and suggested they stop making payments to creditors, allowing interest and fees to snowball. Once the balance in the designated account was large enough, the companies would purportedly negotiate a lump-sum settlement with creditors to reduce the overall debt by half.

    But in many cases, creditors sued the debtors for non-payment, and settlement companies took their fees from the special accounts without delivering the promised relief. Since the start of the recession in 2007, the Council of Better Business Bureaus has received more than 3,500 complaints about debt reduction companies.”

    Another good article from NY Times:

    http://www.nytimes.com/2010/06/19/business/economy/19debt.html?_r=2

  10. Here’s a response from guest post author Daniel regarding the new laws:

    “The laws change is very limited. Here’s the things it does do now:

    * require debt relief companies to make specific disclosures to consumers;
    * prohibit them from making misrepresentations; and
    * extend the Telemarketing Sales Rule to cover calls consumers make to these firms in response to debt relief advertising.

    However, it doesn’t apply to non for profit companies. All these companies try and make themselves out to be non for profit, so the law is very very diluted.”

    The not-for-profit comment is interesting.

  11. Very skeptical of your intentions, bias and knowledge. You bring up 1099 and make it sound like the client will have to pay taxes on $8000, but you failed to mention Form 982 which can absolve you of that?

    You are also mixing up different program types and generally making assumptions and half-cocked theories based on bad apples.

    I can make up statistics and make blanket judgments too!
    Mohammad Naeem, an attorney, raped and killed a 12 year old child. (true, use google)

    Therefore, it is my opinion that all attorneys rape and kill children.

  12. First let me state I too am a bankruptcy attorney.

    I absolutely agree with the type of debt settlement companies Daniel refers to. I live in an area that was hit far greater with the effects of the financial downturn (San Joaquin County). I try to approach every clients case with a fresh set of eyes on what I would tell my mother or father to do if in the situation.

    I usually ask my client do you see an alternative way of dealing with the financial distress in the next 2-5 years. The sort of debt settlement companies that Daniel talks about are the WORST out there. Multiple clients come into my office after they have paid a boatload to these companies and are then sued. The problem is even when they do settle some debts, they are almost always the smallest cards. This is completely illogical, because the smaller the card the less likely they are to sue (Unless they are CHASE, who sues everyone with just about balance).

    Now, with all that being said, there are some reputable debt settlement companies out there. You want to look for ones that are non-profit and that make monthly payments towards your cards. Depending upon your financial ability, there are companies out there that will negotiate a repayment, you pay them one amount each month and they in turn make a payment on each card. You are not going to see any promises of settling cards for pennies on the dollar because you are going to pay every penny you owe at say 5-15%. For some clients this is a feasible solution, for others even when stretched over a 5 year period, it cannot be done. Those are the clients best suited for bankruptcy.

  13. What Daniel is pointing out is that debt settlement companies are
    AS BAD AS lawyers, LoL

  14. This just reinforces my belief that anything advertised on AM radio or daytime broadcast TV is a scam.

  15. Disappointed says:

    I have been a fan of this blog for a while now but have to say it is a bit of a stretch to call this a guest post. I’m not an advocate of debt settlement by any means, but this seems little more than a generalized one sided advertisement.

  16. Sure, the guest poster is biased. So are all guest posters, but Daniel explicitly states his biases upfront, and still provides his valid experiences, his resulting opinions, and some useful stats. I think a casual reader would learn many potential pitfalls from debt settlement companies this post.

    I never receive any compensation from guest posters. In fact, *I pay them*, unless they decline. They provide useful content, and in return they also get a link, which is another form of compensation to them for their work.

  17. It seems people are mixing things up here. There is a big difference between non-profit consumer credit counseling and for-profit debt settlement.

    Non-profit credit counseling doesn’t reduce balances. Instead, the reduce interest rates and extend the time you have to pay off the balance.

    For-profit debt settlement companies, on the other hand, go in and negotiate your debts down for reduced amounts. Some will extend the time you have to pay off the debt as well.

    Just like any business — mechanics, mortgage brokers, EVEN LAWYERS — there are good and bad debt settlement firms out there. People in this situation should consider all options, settlement, credit counseling and bankruptcy, and choose which fits their life, now and in the future, the best.

    It should be noted that the FTC recently enacted new laws that prohibit debt settlement companies from collecting up-front payments. Another part of that law said they cannot appear to be a government program. Both these actions are now illegal.

  18. Thanks for the advice. I agree with your opinions.

  19. Hi:

    I authored the column and wanted to just address a few concerns in some of the comments. First, my advice is absolutely biased as I am a Bankruptcy lawyer and think my way, for the vast majority of cases, is the least expensive, and the best for clients. Having said that, I haven’t been paid anything at all, and I actually declined whatever gift certificate was offered for winning the guest blogger contest. I just say what I feel and let people decide if they agree. Not everyone will, thats normal. What I can tell you is that, just like debt settlement companies, there are collection lawyers that are JUST as horrible in NY and that take advantage of the rules in many cases. I put them in the same bunch as I do the agencies. In addition, if people were satisfied with these debt settlement agencies, they likely wouldn’t be coming to me to file for Bankruptcy. I didn’t write the post because I thought this would get me clients. I have a great practice that I enjoy tremendously. I think its good business to tell people when you think they’re getting ripped off. People like when you tell them the truth (even if some people think its subjective). I think we’ll see more and more Attorney Generals going after debt settlement agencies in the future. I was just giving my two cents on the issue based on what I say, every single day.

  20. Then I retract my baby-raping comment. :)

  21. The FTC just rolled out a new regulation to curb some of these upfront fees. That should put some of the scammers out of business.

    I have a hard time imagining a consumer with enough cc debt that they can’t manage it themselves by selling their assets, reducing expenses, and bringing in more income. Aren’t these methods just bailouts? I understand if large scale business debt takes someone down, but credit cards?

  22. John Cees Freedome says:

    I believe that bankruptcy must strictly be the consumer’s absolute last option, because:
    1. It stays on your credit report for 10 years and it is challenging to erase it.
    2. The stigma of bankruptcy rarely leaves you. Next time you fill out an application to rent an apartment, buy a house, get a job, etc., one of the questions you need to answer will be, “Have you EVER filed for bankruptcy?” Notice that there is no timeline given.
    3. More than 60% of those who enter into a Chapter 13 bankruptcy repayment plan fail to complete the repayment program mandated by the court.
    4. Bankruptcy can be expensive, costing upwards of $4,000 or more to file.

    Bankruptcy, however, is far better than committing suicide over credit debt. There have been reported instances where consumers have chosen to end their life, as a means of escaping debt [ii]. If you believe that you may be on the verge of harming yourself, please call the National Suicide Prevention Lifeline at (800) 273-TALK.

    I do agreed that debt settlement companies are scams and consumers are best served by staying away from them. The best approach is debt settlement on your own. You can be out of debt, usually in six months. This is what I promote at wwww.johnceesfreedom.com

  23. No Debts, No Regrets says:

    Due to illness and then unemployment, I accummulated a large amount of debt. I have been able to pay off about 30% of it so far. One of the ways I did this was to create what I call the Debt Buster spreadsheet. I have posted it on my blog where anybody can download it for free. I will also help anybody who needs it on how to use it. Just post a question and I’ll answer it as soon as possible.

    I agree with the comment above me, no matter how much debt you have, it is not worth taking your life. There is hope and it can often be found on blogs like these where you can read about other people who are facing the same problem.

    Good Luck!

  24. YourFinancialEducationTutor.com says:

    My understanding of this guest post is that you should not use a debt settlement company to help you with your debt issues. But I must say that although I am not a fan of debt settlement companies I do believe that there are some that can help those in debt out.

    But the best way for any individual to handle their debt issue is to educate themselves about debt relief. There is so much debt relief information around nowadays that can help you out. After you do your research, you can start creating a debt management plan on your own.

    Remember that everything those debt settlement companies say they can do, you can do it for yourself. Plus it will be good for you to learn how to deal with your creditors. As a matter of fact, your creditors would love to deal with you instead of some third party. So do some research first and then if you feel you are not making progress then consider using a not for profit credit counseling agency instead of a debt settlement company.

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