Is “Debt Relief” a Scam?

Quick Answer

Some debt relief companies are scams, and even the legit ones are risky and expensive. Some creditors refuse to work with debt relief companies, and even when it’s successful, debt relief can do major harm to your credit and raise your income tax bill.

Young woman checking her mobile phone, looking skeptical and questioning the legitimacy of debt relief organizations.

Companies promising debt relief services include an abundance of scammers, but even lawful debt relief companies are expensive and risky—and often leave customers with more debt and fewer borrowing options than when they hired them.

Here's what you should know before you do business with a debt relief company.

Are Debt Relief Programs Legit?

Debt relief companies, whether bogus or on the level, operate on the same premise: They offer to negotiate with creditors on your behalf to persuade them to accept less than you owe.

Scammers typically collect fees for these services upfront and then do little or nothing—a situation that leaves you worse off than when you hired them. But the methods legit debt relief companies use can do damage too.

Debt relief companies typically instruct you to stop making payments to the creditors they plan to negotiate with, and instead have you make a fixed payment each month into a special escrow account they set up (and for which you will likely be charged monthly fees). The theory is that they'll eventually offer your creditors lump-sum payments from the escrow account in exchange for settling your debt. This approach doesn't always work, and even when it does, it can lead to steep fees and potentially a higher income tax bill for you.

What to Know Before You Enroll in Debt Relief

Lawful debt relief companies don't do anything you cannot do yourself. If you'd like assistance negotiating with your creditors, alternatives such as certified credit counselors are typically less expensive and more helpful.

Debt relief companies' marketing materials typically play up how much money they can save you, but legitimate credit relief companies are required by law to disclose risks involved in their approach, which include:

  • Creditor refusal: Creditors are under no obligation to work with credit repair companies, and one or more of yours may refuse to deal with them.
  • Late fees: While you are funneling funds into the debt relief escrow account, any debt payments you're skipping will likely lead to late charges that increase your outstanding balances—adding to the sums you ultimately hope to settle.
  • Credit damage from late payments: Any payments you miss while redirecting funds into a debt relief escrow account will result in delinquencies on your credit reports, which can have serious negative consequences for your credit scores.
  • Credit damage from settled accounts: If a creditor accepts a debt relief company's proposal, it typically reports your account to the national credit bureaus as "settled." This can further damage your credit scores.
  • Exposure to lawsuits: Creditors can file suit against to recover unpaid bills at any time during the debt relief process. Debt relief does not shield you from litigation.
  • Account closures: Creditors who accept partial payment to settle your account typically close your account once you've paid the agreed-upon sum.
  • Potential difficulty with new credit: The combination of closed loan or credit card accounts and heavily damaged credit reports can make it difficult to borrow money for several months or years.
  • Possible income tax liability: Any full or partial debt a creditor forgives may be taxable income in the eyes of the IRS, so successful debt relief could increase your federal income tax bill.

Fees charged by lawful debt relief companies are typically calculated as a percentage of the total amount of debt they settle on your behalf. If, say, they persuade your creditors to accept $10,000 to settle debts of $20,000, your fee could be 15% to 25% of $20,000—$3,000 to $5,000.

You're typically expected to pay those fees by continuing monthly deposits to your escrow account—a process that could take years, depending on the size of the payment. During this time, you'll likely be charged maintenance fees on the escrow account.

Signs of Debt Relief Scams

While the costs of legitimate debt relief companies can be staggering, scam companies just flat-out steal your money. Here are some signs you're dealing with a scammer:

Demanding 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.

Phone, Email or Text Solicitations

Cold-call solicitations from debt relief companies could be scams. Before you give any personal information to any company that reaches out to you, research the business carefully.

Promising Results

Nothing is guaranteed in the debt relief process, so anything that sounds like a promise of results is untrustworthy.

Claiming Special Methods

Claims that legal maneuvering, technical tricks or exploiting "hidden" government programs can help you get out of debt are a favorite ploy of student loan scammers, but that approach from any debt relief company should serve as a red flag. The techniques legit debt relief companies use are well established, and you can apply them yourself without paying anything.

Advising You to Ignore Creditor Communications

If a credit relief company tells you to ignore communications from your creditors, they must also make it clear that doing so can have significant downsides, including accelerating debt collection efforts such as filing lawsuits against you.

Promising Protection

Only a bankruptcy filing can stop a creditor from filing a debt collection lawsuit against you, so don't trust any debt relief company that promises to shield you from legal liability. Federal law requires debt collectors to cease communications with you if you (or a debt relief company representing you) asks them to do so in writing, but that cannot prevent them from suing you.

Alternatives to Debt Relief Companies

Before you sign on to any debt relief program, consider these alternatives first:

  • Credit counseling: If you're considering debt relief, you'd be wise to consult first with a certified credit counselor, who can help you sort through your finances and household budget and get a handle on your best options. Nonprofit credit counseling organizations typically charge modestly for their services, and some offer sliding-scale fees.
  • Debt management plan: If a certified credit counselor determines that you can't realistically cover your existing debt, they may be able to work with your creditors on your behalf to set up a debt management plan (DMP). With a DMP, you make full or partial payments on what you owe over time. Doing so typically ends up with closure of your accounts and can impact your credit, but is a better option than debt relief or bankruptcy. Fees for this process are likely to be far lower than you'd pay a debt relief company.
  • Debt settlement: Debt settlement can be another name for for-profit debt relief services, but it's also an avenue you can pursue on your own. If you cannot afford to repay a debt, you can approach any creditor with a proposal to make partial payment to settle what you owe. Understand that the process is a negotiation: Be prepared for counter-offers and make sure you're able to pay any settlement amount you accept. Also understand that creditors can simply say no, but it doesn't hurt to ask.
  • Debt consolidation: If interest charges on credit card balances are a source of runaway debt, and if you still have reasonably good credit, you could consider debt consolidation. Using a relatively low-interest personal loan or even a credit card with a 0% introductory APR can put the brakes on compounding interest and may make it easier to pay off your high-interest debt.
  • Servicemembers' Civil Relief Act: If you are a member of the armed forces on active duty, you may be entitled to postpone or suspend payments on mortgages, credit card accounts and other debts under the Servicemembers' Civil Relief Act.
  • Bankruptcy: If, after a realistic appraisal of your debts and income, you conclude that you cannot pay your existing debts and the options above won't work, filing for bankruptcy may be your only alternative. Bankruptcy can cancel many (but not all) debts. It has major negative impacts on your credit scores that can last for seven years (Chapter 13 bankruptcy) or up to 10 years (Chapter 7), but it can be the basis for a fresh start if you're overwhelmed with debt.

The Bottom Line

If you're considering working with a debt relief company, it's important to understand the very real risks, and to have 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.