Are Debt Relief Companies Legitimate?

Are Debt Relief Companies Legitimate? article image.

Some debt relief companies provide helpful services to people facing financial difficulty. But if you're considering using one, be sure you understand what they'll charge you, and be wary of scammers.

Even legitimate debt relief companies, sometimes known as debt settlement companies or debt adjusting companies, generally don't do anything you cannot do yourself for free—but they may be able to help you to get your creditors to accept part of what you owe them.

How Debt Relief Companies Work

Debt relief companies negotiate with your creditors with the goal of getting them to accept partial payment on the debts you owe. Before they begin negotiation, debt relief companies typically tell you to stop paying your debts, and to make monthly deposits instead into a savings account they set up for you. After the account balance reaches a target amount, the debt relief company approaches your creditors and offers partial repayment, often with the implication that you may file for bankruptcy and leave the creditors with nothing.

If negotiations are successful, your creditors will typically allow you to set up a payment plan that lets you pay off a fraction of what you owe—as little as 40% to 50% of your original debt, or as much as 80%. Debt settlement companies typically keep 15% to 25% of the total debt amount for each settled account as payment, so the total savings to you could be minimal. Debt relief companies may also charge fees for setting up and maintaining the savings account as you pay off settled debts, which could take many months, depending on negotiated terms.

The best outcome you can hope for in this arrangement is that your creditors will agree to settle your accounts—close them in exchange for partial payment. This eliminates your debt but leaves a significant negative mark on your credit report for every closed account—each of which can lower your credit scores for up to seven years. That's a better option than bankruptcy, but the cost could be high—in fees to the debt relief company, damage to your credit along the way, loss of available credit (from the closure of your accounts) and even a higher federal income tax bill.

The federal Consumer Financial Protection Bureau warns that debt relief companies often cannot negotiate settlements with all creditors. In a worst-case outcome, in which none of your creditors agree to settle, you could end up in tougher straits than you were in to begin with: The debt relief company will return your deposit, minus account maintenance fees, but your credit history will be riddled with missed payments and your accounts may be turned over to collection agencies or the subject of lawsuits against you. Worst of all, your original debts could still be there—and bankruptcy could be your only recourse.

Signs of Debt Relief Scams

In a nutshell, working with a debt relief company is risky and expensive. So, you should be suspicious of any company that tries to convince you otherwise.

Before signing you on as a client, any legitimate debt relief company should explain their fees, the potential outcomes (good and bad) of using their services, and other costs of working with them. As part of their enrollment process, they should conduct a detailed review of your finances and review potential outcomes for you.

Beware debt relief company that use any of the following tactics:

  • Seeking payment upfront: Lawful debt relief companies collect fees only after securing settlement agreements with creditors. Upfront payments, which scammers may characterize as "voluntary donations" or fees, are not on the level.
  • Contacting you by phone or email: Debt relief companies that do cold-call solicitations could be scams. Before you work with any such company, research the business carefully.
  • Promising or guaranteeing results: There are no guarantees in the debt relief process, and anyone suggesting otherwise is untrustworthy.
  • Advising ceasing communication with creditors without explaining consequences: Ignoring communications from creditors can lead them to step up their debt collection efforts and could prompt them to file suit against you sooner than they would otherwise in an attempt to secure repayment.
  • Touting "new government programs" or other legal loopholes that can get you out of debt: These are especially popular with scammers pitching bogus relief from student loans, but they can apply to credit card debt, car loans and mortgages as well. If you have a loan issued through a government agency, that agency will reach out to you in writing with any information about the loan.
  • Promising to stop all debt collection calls and lawsuits: The federal Fair Debt Collection Practices Act gives you (and third parties acting as your agents) the right to tell debt collectors to stop communicating with you, but nothing short of bankruptcy protection can stop a creditor from filing a debt collection lawsuit against you.
  • Requiring financial details or payment info before explaining their services: Bona fide debt relief services will be transparent about their offerings and costs, and you shouldn't give anyone account information unless you're hiring them to represent you.
  • Trying to enroll you without reviewing your financial situation in detail: Pressure tactics aimed at getting you to sign up quickly, particularly if they entail a fee or providing payment information (bank account numbers, credit or debit card information, etc.) are not acceptable. "Sign up now and an adviser will follow up soon" is not a legitimate approach.

Before engaging any debt relief service, it's always wise to check with your state's attorney general and consumer protection agency.

Are Debt Relief Programs Really Worth It?

Working with a legitimate debt relief company can be valuable, but keep in mind that:

  • You can negotiate with your creditors yourself to settle your accounts.
  • Settled accounts appear on your credit reports for up to seven years and have significant negative impacts on your credit scores.
  • Creditors aren't obligated to work with debt settlement companies, and yours may not cooperate.
  • High fees mean that debt settlement ultimately may not bring you major savings.
  • The portion of debt that's forgiven through the debt relief process may be considered taxable income, and could boost your federal income tax bill.

The decision of whether to work with a debt settlement company is a personal one, but if you're considering it, it's important to go into the arrangement with your eyes open, and with confidence in the company you choose. Check into the company's background, ask plenty of questions, and trust your instincts if the answers don't seem credible. Monitor your credit report, which you can do for free with Experian, to understand where you're at and how any debt settlement actions affect your payment history and thus your credit score.

Before seeking debt settlement, it may be worthwhile to work with an accredited credit counselor, who can review your debts and financial situation and lay out all your options, including where debt settlement services might fit in, if at all. Consulting a credit counselor can help you understand where you may need help without pushing you into a risky plan that could hurt your finances for years to come.