If you've fallen on hard times and you're overwhelmed with debt, you've probably given some thought to hiring debt settlement services from a company. Their ads are everywhere, after all, telling you you can settle your debt "for pennies on the dollar," "get rid of your debt in 1-2 years" and even hinting at "secrets your creditors don't want you to know." Of course, debt settlement companies have secrets of their own, so make sure you know how the business works before you even consider hiring someone to settle your debt.
1. Your credit will take a huge hit
When you sign up for debt reduction services through a non-attorney company, they will probably talk at great length about how much you MAY save, but they probably won't tell you too much about the damage to your credit. Their services will require making a monthly deposit into a bank or trust account and, once this money gets to a fair amount, they will attempt to reach a settlement on your debts.
In the mean time, you will probably be told to stop making payments on your accounts to create leverage and build up that savings account. This means you will wrack up tons of red marks on your credit report from missed payments, as well as a permanent mark if the debt is successfully settled. You will also accrue more late fees and interest on your accounts.
2. There is no guarantee
Debt settlement companies may advertise that they can settle your debt for 20 to 40% of your balance owed, but there is no guarantee your creditors will go along. In fact, many creditors immediately accelerate their collections process when they learn you are working with one of these companies and trying to settle, and they will refuse to agree to any offer. They may even sue you, in which case the company cannot represent you in court or give you any legal advice.
According to federal law, companies that offer debt settlement services cannot charge you in advance for services, and they cannot charge you until they successfully settle at least one debt. Unfortunately, this isn't how most operate.
3. You may pay a flat fee based on your current balance
In many cases, you will be required to pay a flat percentage of your current outstanding balance, regardless of how much your debt is settled for, or if it's settled at all. Many companies will even put off doing any work until they've received their full payment, which may take one full year as their fees come out of your monthly deposits. Meanwhile, you will still receive calls and letters from collection agencies, and possibly even legal summons and wage garnishments.
4. You may owe taxes on forgiven debt
That's right, even if your debt is successfully settled, you may be on the hook for a huge tax bill in addition to all those fees you paid. The IRS considers any debt over $600 forgiven as taxable income. You will be issued a 1099 and the taxes can be substantial! It's not uncommon to find you owe thousands more after it's all said and done, and if you can't pay, expect hefty interest rates and fees from the IRS on top of everything.
While turning to debt negotiation services may help you get over your substantial debt, it's not the win-win situation it appears. Weigh these important factors carefully and remember that it may be a better option to work with a debt settlement lawyer, not a company, or even consider bankruptcy as an alternative.
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