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Debt Settlement: Don't Get Fooled

A few weeks ago, I visited a local vocational school to talk to students about credit and to provide them with individual credit counseling assistance. One of the gentlemen, Steve, who stayed after to have an individual appointment, said he wanted to know what his credit looked like now that he was using a debt consolidation service. Steve is a single 32-year-old. He has worked in the construction trade all of his life but was a casualty of the housing crisis and is now unemployed.

I asked him how long he had been using the service, and he said it was about six months. He said his payments on the debt consolidation program were half of what he had been paying previously. A red flag immediately went up for me.

We pulled his credit report and could see the damage right away. Until roughly five months ago, Steve had a perfect payment history. There were no late payment marks on the report prior to that time. After that point, accounts showed a history of 30, 60, and 90-day late payments. The creditors were not receiving any money. Steve had unwittingly signed up for a debt settlement plan through a debt settlement company. It was not debt consolidation or even debt management.

When you settle a debt, it means you pay off a portion of what you owe to the creditor. You make monthly payments to the debt settlement company, which then takes your payments and deposits them into a savings account. As you continue to make payments, the funds grow until the debt settlement company feels there is enough money to make a deal (negotiate) with the creditor. That may sound very enticing, but, as Steve found out, that discount in debt comes at a very high cost - namely, your credit and your pocketbook.

The debt settlement company is holding on to your money, so no money is getting to your creditors. This can result in a severely damaged credit report, creditors suing you to secure payment, and additional fees and interest being added to your account. In fact, many people who do not realize they have entered into a debt settlement agreement only find out when they receive notice that they are being sued.

So how do you know the difference between debt settlement, debt consolidation, and debt management? You have to ask the right questions.

Debt consolidation involves obtaining a loan to pay off your debts and then making one monthly payment to your new lender. For more information on the pros and cons of debt consolidation, visit our Resource Center.

Debt management plans consist of consolidating your payments on debt. You work with a credit counseling agency that contacts your creditors and asks them to reduce your interest rates, bring your accounts back to their current status, and stop any late fees or over-the-limit fees. Your payment is made to the credit counseling agency, which distributes it to each of your creditors on the plan. You can read more about debt management plans by following this link.

Do some research if you hear ads promising to help you get out of debt quickly, easily, or by paying less than you owe. Ask the company:

  • If they are a debt settlement company.
  • About their fees; are there set-up and/or monthly fees? Debt settlement companies are not allowed to charge upfront fees for their services.
  • How their program impacts your credit (be careful because many will come back with comments about how negative your credit is right now).
  • If they are settling debt, what do you have to do to get your money back if the debt settlement doesn't work?
  • What are the qualifications of their counselors? Are they accredited or certified by an outside organization? If so, by whom? If not, how are they trained? Try to use an organization whose counselors are trained by a non-affiliated party.
  • Are they licensed to offer their services in your state?
  • Do they offer information? Are educational materials available for free? Avoid organizations that charge for the information.
  • Will you have a formal written agreement or contract with them? Don't sign anything without reading it first. Make sure all verbal promises are in writing.

It can be very confusing trying to differentiate between the different types of debt management programs out there. Unfortunately, if you pick the wrong plan, the damage done to your credit can be very costly and difficult to recover from. If you need help managing your finances or coming up with a plan for repaying your debts, contact a certified credit counselor. Call the number at the top of your screen or click on the Get Started Now button to get help today.

Published Jul 22, 2011.