The truth about credit repair services and debt settlement plans
In this article:
If you are having financial problems, you may be approached by credit repair services or companies to settle your debts for “pence on the dollar”. This is possible, but unlikely. The costs are high and there are better options.
- You can’t delete offensive credit report history if it’s true – only if it’s an error
- Debt settlement is risky because it may not work; you could end up in court and your credit ruined
- Reputable non-profit credit counselors, debt management plans, and law firms can provide real help
You can remove inaccurate information from credit reports yourself, or your mortgage lender can help you with a “quick reappraisal” service. And reputable, non-profit credit counselors can help you manage your debts and provide advice.
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How debt settlement works
Debt settlement works like this:
- You stop paying your creditor(s)
- You give the money you would spend to make your payments to a debt settlement company
- When you have saved approximately half of your outstanding balance(s), the company will contact your creditor(s)
- They negotiate a lump sum payment to settle your debt and zero out your balance
- You pay the debt settlement company; typically this is 20% of what you save
If you owed $10,000, for example, you would pay $5,000 to settle your debt and $1,000 to the debt settlement company. But you’ll have to pay taxes on the $4,000 that your creditors write off.
What can go wrong with debt settlement
Debt settlement is a minefield that you need to navigate carefully.
A disreputable company may run away with your money and provide no service
A bad company could take your payments and provide no service. This has happened often enough that the Federal Trade Commission (FTC) warns consumers to choose a service very carefully.
“Before dealing with a debt relief service, check with your state attorney general and local consumer protection agency. They can tell you if any consumer complaints have been filed about the company you are considering doing business with. Ask your attorney general if the company must be licensed to operate in your state, and if so, if so.
Your creditors will constantly and insistently contact you for payment
Your creditors will step up their demands for payment and may refer your account to a collection agency. Although the law prohibits certain aggressive behavior, such as threatening jail time, showing up at your workplace, or calling late at night, you’ll likely be inundated with demands for payment by phone and mail.
Over the months, you will probably have to set aside the necessary funds, it can drive you crazy. High stress levels are unhealthy and bad for your relationship with your family or loved one.
Your credit will be deleted
Every late payment – 30, 60, 90 days and more – will knock your FICO score down like a rock thrown off a cliff. And even if you settle successfully, the creditor will add a code to your credit history indicating that you settled the debt for “less than the amount owed”, which also has a major impact on your score.
Your accounts will be closed and you won’t be able to enjoy decent interest rates and terms for very long. Between late payments and the ding for not paying your account in full, it can take years to recover from the debt settlement process.
You could be sued
For your creditors, debt settlement is optional. They don’t have to. And if they have reason to believe that you are not destitute, chances are they will sue you. In this case, you have a judgment against you, which can affect everything from your credit score to your job prospects.
In addition, not only will you be responsible for the entire outstanding balance, but you will also have to pay court costs and attorney’s fees. Look at the fine print of your credit card agreement. That probably says something to that effect.
You will need the IRS
Anything your creditor cancels is considered income to you by the IRS. If you’re in the 25% bracket, you’ll owe $250 for every $1,000 saved. And if you don’t, you’ll have another creditor – the IRS. And the agency is a much more powerful creditor than any credit card company. This debt cannot be cancelled.
So if we look again at the numbers in the example, your savings are actually small, considering the cost and aggravation involved:
- You owe $10,000
- You settle for $5,000
- The settlement company receives $1,000
- You owe the IRS $1,250
So instead of paying $10,000, you will lose $7,250. It’s not exactly the “cents on the dollar” advertised by these companies. And you are taking a huge risk.
What is Credit Repair?
Credit repair services cannot legally do anything that you cannot do yourself. They and you can contact creditors and credit bureaus to correct inaccurate information on your credit reports.
- You cannot eliminate the correct information
- Asking for a new tax ID or social security number to dodge a sketchy credit history is illegal
- Buying “trading lines” or authorized user accounts is very expensive, doesn’t work well, and is fraudulent
- Many of these companies simply dispute every ding on your report and hope the creditor won’t confirm it.
Unfortunately, the only reliable form of credit repair is to have credit bureaus and creditors erase inaccurate data and pay your bills on time for months or years.
Alternatives to Debt Settlement
There are reputable alternatives to debt settlement that can better solve your problem. Here they are, from least to most drastic.
A reputable non-profit credit counselor can help you learn how to budget and come up with a plan to pay off your debt the old-fashioned way.
Credit counselors offer free educational materials and workshops. They should be certified and trained in consumer credit, money and debt management, and budgeting. Your advisor will review your financial situation with you and help you develop a personalized plan to deal with your money problems.
Your first counseling session usually lasts an hour, and you can schedule follow-up sessions.
Avoid companies that charge more than a nominal fee or give you a high-pressure pitch. You can find out if a credit counseling agency has filed consumer complaints by checking with your state attorney general and local consumer protection agency.
The United States Trustee Program also maintains a list of credit counseling agencies approved to provide pre-bankruptcy counseling. You can probably trust them to help you too. Member agencies of the National Foundation for Credit Counseling must adhere to a code of ethics and are likely to be trusted.
Debt Management Plans (DMP)
Your advisor may be able to work with your creditors to reduce penalties and even your interest rates. If you need more help, your counselor can recommend a debt management plan (DMP).
A DMP combines your unsecured debts, such as credit cards. You make a one-time payment in the plan, and that, in turn, pays your creditors. In most cases, your interest rate and/or payment is reduced to make it more affordable.
It is very important that you choose a reputable company because you will pay them money and believe that they will pay your debts.
If you can’t pay off your debts within five years with a DMP, you may need to go further.
Chapter 13 Bankruptcy
Chapter 13 is very similar to a DMP. However, under Chapter 13, your creditors have no choice but to participate. A bankruptcy court determines what you can afford to pay each month.
You make the payment to the court and the court, in turn, pays your creditors. In this case, you can actually pay pennies on the dollar. After 5 years (3 years in some states), all outstanding amounts are written off and you have a clean slate.
If you don’t have the income to make payments in a Chapter 13 plan, you may be eligible for liquidation and full forgiveness of all eligible debt.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is only available to those who pass a “means test” and cannot reasonably be expected to make payments to their creditors. Instead, your non-exempt assets are sold and the money paid out to your creditors. Any unpaid amount is canceled.
It’s a drastic solution that will affect your credit rating for many years. But for some, it’s the only option.
Alternative to credit repair
If you’re applying for a mortgage and your credit report contains inaccurate information, your lender can help you remove it quickly. This is called a “quick re-score”.
Rapid reassessment companies only work with lenders, not consumers. You will need to provide proof that an entry on your credit history is inaccurate. For example, a copy of a voided check showing that you paid a bill on time, but it was flagged as overdue.
Re-scoring typically costs less than $100 (in many cases between $20 and $50) and your report is cleaned up in about 48 hours.
Just Say No to Bad Debt Settlement or Credit Repair Ideas
With so many less risky and less expensive options, don’t fall prey to over-the-top sales pitches and too-good-to-be-true advertisements.
There are some good options here for those who need real help.
Check your new rate (February 2, 2022)