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Before signing up with a debt relief company, it's very important that consumers do their research first.
A debt settlement company works on behalf of a borrower to motivate the lenders to accept less money than what is owed.
Although some consumers might be able to achieve the same end result through a negotiated settlement with each individual lender, it is often easier to use the combined strength and expertise of a larger company to manage the potentially complex process.
The goal in debt settlement is to reduce the total amount due to a manageable amount for the borrower. Most consumers don't have the persistence or patience to work directly with each lender, so they decide to engage the services of a debt settlement company. According to the Federal Trade Commission, debt settlement programs are typically offered by for-profit companies. They may deal with general debt, or specialize in certain debt such as credit cards or medical bills.
Instead of paying creditors, the consumer sends money every month to an escrow-like savings account that the debt settlement company manages on their behalf. The company does not use this fund to pay the creditors monthly. Only when the account accumulates sufficient funds is it used to pay off a negotiated settlement amount.
Questions to Ask a Debt Settlement Company
Working with a debt settlement company can have both risks and rewards. The borrower should first conduct research on potential firms to determine if there are any cautionary reviews or Better Business Bureau complaints. Once a reputable company is found, there are certain questions consumers should ask to help weigh the benefits and possible negatives before signing up:
- What is your company's background? Learn about the company first. Find out when it was established, how large it is, and how many borrowers it has helped to settle debts. Consumers should be sure the company is licensed to do business in their state.
- What debts can you negotiate? Not all debt settlement companies can manage all debts. Most typically work only with unsecured debt. It is usually not possible to negotiate or reduce mortgages, secured loans, or federal student loan debt. A larger company with a longer track record in debt settlement will be likely to have better relationships with major credit companies.
- How does your specific program work? Companies may have differences in their approach to debt settlement. A few may offer a loan to pay off the settlement amount, while most work on the accumulated savings approach. The consumer must learn each individual company's strategy, so there are no surprises down the road. Find out how long it usually takes the average consumer to achieve freedom from debt using this specific program. It can take two to four years, or sometimes more, depending on the amount of debt involved and the consumer's current financial situation.
- What are your fees? It is very important to understand exactly how much the debt settlement process will cost. There could be a percentage fee incurred for working with the company, as well as additional fees to maintain the separate escrow-like account. These fees may vary from state to state.
- What effect does debt settlement have on a credit rating? It is highly probably that the consumer's credit rating will go down during the settlement process. If somebody was already behind on payments, the time required for the separate account to grow may cause the loans to go into default. Lenders who do not agree to the debt settlement program may continue to add late fees and other penalties, further lowering the credit rating.
- What is the tax impact of debt settlement? If a substantial portion of debt is forgiven, it can potentially be construed as a form of income. This could actually lead to an additional tax burden for the consumer. If the borrower is insolvent, it may be possible to exempt this amount.
- What are your accreditations and certifications? Consumers should make sure that they use a trusted and legitimate debt settlement company. Check the company’s rating with the Better Business Bureau and check to see what accreditations and certifications they have, before signing up.
- What is your customer service philosophy? Being in debt and working with credit companies can be a lonely and overwhelming experience. There should be a regular communication schedule, and the consumer is entitled to know that the debt settlement company is available to help and answer questions whenever the need arises.
Red Flags to Avoid with a Debt Settlement Company
It can be hard to sort through the variables associated with debt settlement, but the consumer must still do the necessary homework to make sure a potential debt settlement partner is legitimate.
Potential red flags include:
- Charging fees before a debt is settled.
- A claim that the company can stop all debt collection calls and letters.
- Offering a guarantee to eliminate all debt.
- Failure to provide a full, written disclosure.
- Exaggerated estimates of savings, without taking fees or interest into account.
A legitimate debt relief firm should not discourage the consumer from seeking alternative debt relief options, such as a debt consolidation loan, or consulting with a reputable credit counseling agency or a bankruptcy attorney.
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