When struggling with debt, consumers often do not know what their best options are. There are three different services that some of our clients frequently consider before filing for bankruptcy: Debt Settlement, Debt Consolidation and Credit Counseling. These terms are sometimes used interchangeably but they are indeed different and have very different costs, effects and success rates. Please note that in this blog, we will not be discussing bankruptcy as an option, although it is often the best way to get a fresh financial start.
Debt Settlement
Debt Settlement is a widely-marketed form of for-profit credit card debt reduction that can be quite problematic for the consumers who engage in it. In a debt settlement “program,” offered by companies such as National Debt Relief and Freedom Debt Relief, a debtor is advised to stop paying their credit cards and to start making monthly deposits into an account set up by the debt consolidation company. This is done in order to accumulate the funds necessary to negotiate lump sum on the accounts in default which are typically credit card debts.
There are many dangers associated with hiring a debt settlement company:
• Many of these companies accomplish little for their customers and charge large fees. Although they advertise that they will settle debts for a fraction of the debt, debt settlement companies fail to clearly disclose that the average settlement is 50% of the balance
• Debt settlement companies often charge up to 25% of the total balances as a fee. As a consequence, debtors are still paying back the equivalent of 75% of their balances before taking into account any potential negative tax consequences.
• Debt settlement companies try to have their full fee paid in the first few settlements.
• Debt settlement programs generally takes between 36 and 42 months to complete.
• Many creditors are unwilling to negotiate with debt settlement companies. Since the debts from these creditors is not part of the settlement plan, the debtor’s savings is even further reduced.
• Even if the debt is settled, there may be potential tax liability to the consumer from the cancelled debt because the forgiven amount is considered by the IRS to be taxable income. Creditors may issue a 1099-C to the debtor for the debt cancelled in the settlement.
• As the accounts being settled are in default, late fees and interest continue to accrue.
• Consumers’ credit histories are severely damaged when they stop paying their debts. As their accounts go into default and often into collection.
• Consumers who ignore ongoing collection efforts that result from not paying their credit card bills are subject to creditors’ collection efforts, including lawsuits, wage garnishments and restrained (frozen) accounts.
To summarize, debt settlement companies often leave consumers in worse financial straits than when they began. According to the Association of Settlement Companies, an industry trade group only 34% of those signed up for debt settlement plans actually settle any debts. The number of consumers who actually complete their debt settlement plans is much like much lower. The Illinois Attorney General estimate from their research that the number of completed debt settlement plans is less than 9% of consumers who sign up for debt settlement plans actually complete them. Based on their low success rates and potential dangers, our office cannot realistically recommend debt settlement.
Link: https://ag.ny.gov/feature/debt-settlement-companies
Debt Consolidation
While some debt settlement companies may refer to their services as debt consolidation, this is not accurate. Debt consolidation is actually when a consumer obtains a loan with a lower interest rate and uses the funds to pays off their existing higher interest debt which results in a lower overall monthly debt payment. These loans are provided by companies such as Prosper, Lending Club and Best Egg. Since a debtor is essentially trading one debt for another, debt consolidation is not really debt reduction so much as it is interest reduction.
Unfortunately, debt consolidation only works in a limited number of circumstances. First, the debtor’s credit must be sufficient to obtain this type of loan. Second, to make sense, the debtor should have a plan to reduce or prevent the use of credit cards while paying back the debt consolidation loan. Debt consolidation only truly makes sense when the debtor can afford both their monthly loan payments along with their monthly living expenses. Debt consolidation is not the solution if a consumer is overwhelmed by debt and has no hope of paying it off by lowering the interest rate on their debt
Finally, while we do not have statistics on the success of debt consolidation loans, from our own bankruptcy practice we can tell you anecdotally that these loans do not adequately solve our client’s debt problems.
Credit Counseling
Credit counselling is a means of debt management, but unfortunately it has a low success rate because it is often too expensive and can take too long to resolve the underlying debt problem. Credit counseling companies are usually non-profit corporations that are licensed by the state in which they operate. They consolidate the balances of creditors that are willing to take part into a debt management plan. The plan provides the debtor with one monthly payment and a lower interest rate. However, the amount of interest reduction varies and not every creditor is willing to participate in these plans. The debtor also has to make sure that the budget provided by the credit counseling company is reasonable for their monthly expenses. In addition, debt management plans offered by credit counseling companies often take 3 to 5 years to finish. As a result, many participants are not able to complete the plan.
As mentioned above, credit counselling is often too expensive for consumers to afford. Even though the companies are usually non-profit, their clients still have to pay a fee for the service provided. The vast majority of debtors do not continue with a debt management plan after they sign up. According to the National Consumer Law Center, the success rate for a debt management plan is in the 20% completion rate range, or less.
Link: https://www.creditkarma.com/advice/i/understanding-credit-counseling/
Speak With An Experienced Bankruptcy Attorney
If you want to review your best options for resolving debt issues, we recommend contacting an experienced Bankruptcy Attorney. You can contact our office, the Law Offices of David I Pankin, PC, at 888-529-9600 or by using our easy online contact form. David I. Pankin , P.C. is a Queens bankruptcy lawyer with offices conveniently located in Manhattan, Brooklyn and Long Island.
Further Reading on Debt Settlement:
https://www.debtlawyer.com/is-debt-settlement-a-good-idea/
https://www.debtlawyer.com/can-i-cancel-my-contract-with-a-debt-settlement-company/
https://www.debtlawyer.com/debt-settlement-companies-what-they-dont-want-you-to-know/
https://www.debtlawyer.com/what-is-worse-for-your-credit-bankruptcy-or-debt-settlement/
