Debt settlement companies promise relief for those struggling with unsecured debts like credit cards and medical bills. They negotiate with creditors to reduce the total amount owed. But how do they work, and what are the risks?
How debt settlement works
When someone enrolls in a debt settlement program, they usually stop making payments to their creditors. Instead, they deposit money into a dedicated account managed by the company. Once enough funds are saved, the company negotiates with creditors to settle for a lower lump-sum payment.
“Debt settlement companies charge fees typically ranging from 15% to 25% of the enrolled debt,” explains financial expert Eric Tyson. “These costs can add up, so consumers should weigh their options carefully.”
The benefits of debt settlement
For those drowning in debt, settlement programs offer a structured approach to financial recovery. A successful negotiation can significantly reduce what’s owed, helping people become debt-free in 24 to 48 months.
Companies like National Debt Relief have helped clients reduce their balances, with many reporting thousands in savings.
“Debt settlement can provide relief when other options fail, but it’s not a guaranteed solution,” says Andrew Pizor, a consumer finance attorney.
Risks and potential drawbacks
Debt settlement comes with risks. The National Foundation for Credit Counseling (NFCC) warns:
“There’s no assurance that a creditor will agree to settle, and stopping payments can lead to increased fees, legal action, and damage to your credit score.”
Other concerns include:
- Accumulating late fees and interest
- Credit score damage that can last years
- Potential lawsuits from creditors
- Tax liabilities on forgiven debt over $600
“Consumers need to understand that forgiven debt may be taxable, which could create a new financial burden,” warns Mark Kantrowitz, a financial aid expert.
Regulations and consumer protections
The debt settlement industry is regulated to prevent abusive practices. The Uniform Debt-Management Services Act (UDMSA) includes safeguards such as:
- A three-day right to cancel without penalties
- Requirements for companies to keep client funds in trust accounts
- Limits on how much companies can charge
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Despite these protections, scams still exist. Some companies charge upfront fees or promise guaranteed results—both are red flags.
Choosing a reputable debt settlement company
Not all debt settlement companies are the same. Trustworthy firms should be accredited by groups like the American Fair Credit Council (AFCC). Consumers should also check customer reviews and avoid companies that:
- Demand payments before settling a single debt
- Promise complete debt elimination
- Claim they can quickly restore credit scores
“It’s critical to research any company before signing up,” says Lauren Saunders of the National Consumer Law Center. “Many people are better off with credit counseling or negotiating with creditors themselves.”
Debt settlement can be a solution for some, but it’s not right for everyone. Understanding the risks and alternatives is key before making a decision.
