Debt Settlement Firms: Promises too Good to be True

Turn on your TV or radio and you can't escape their ubiquitous pitch: "We will help you achieve debt freedom by settling your debts for pennies on the dollar!" But this claim is too good to be true and it attracts folks so desperate that they will believe almost anything that promises a way out of a life of financial struggle.

As a result the business of debt settlement is booming. Today there are over 2000 such firms up from only about a dozen a decade ago.

According to the industry's trade associations - the United States Organizations for Bankruptcy Alternatives and the Association of Settlement Companies - their 250 member firms have 425,000 customers who have enrolled almost $12 billion in credit card balances in their debt settlement programs.

But what debt settlement firms actually do is very different than the promise of debt freedom. In a typical arrangement, these firms' direct customers to stop making any payments on their credit card debt while at the same time begin making monthly deposits into a special account set up with the debt settlement company. Once the balance in the special account reaches a sufficient amount, the firm claims to negotiate lump-sum settlements with the credit card companies, often for half of the balance of the debt owed or less.

Although this all sounds good, less than one of every three customers successfully completes these programs. At one firm - National Consumer Council, which was shuttered by the FTC in 2004 - less than two percent of customers successfully completed their debt settlement programs.

One of the problems with these programs is the high fees. Debt settlement firms take fees of as much as 35% from every deposit customers make into the special account. Because of this it can take up to three years to build up a sufficient balance to make a lump sum settlement offer.

Another big problem is that you could get sued. Since you stop making payments on your debts altogether, you'll raise the legal ire of your creditors. In response some creditors could slap you with a law suits, wage garnishment or liens on your property that is secured as collateral for the debt.

Before being tempted into a debt settlement program, first try working directly with your creditors. If that doesn't work, then try working with a reputable credit counseling firm, preferably one that is a member of the National Foundation for Credit Counseling. If you have too much debt and there is no manageable way to pay it off, then you may be better off filing for bankruptcy. Both of these options are better than getting tangled up in a debt settlement scheme.

Ray Martin

View all articles by Ray Martin on CBS MoneyWatch»
Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.

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