Are Debt Settlement Companies Legitimate?

The NFCC often receives readers questions asking us what they should do in their money situation. We pick some to share that others could be asking themselves and hope to help many in sharing these answers. If you have a question, ask an expert.

Q: Are any debt settlement companies legitimate? Do they have to be licensed?

A. The debt relief industry has been growing in recent years, and debt settlement companies, also known as debt relief or debt adjusting companies, have been a part of that growth. Debt settlement is not the right repayment strategy for everyone. It usually benefits people who are already in debt and cannot afford any other debt relief option and are trying to avoid bankruptcy. There are legitimate debt settlement companies, and in most states, licenses are required. They must abide by industry regulations that seek to protect consumers. However, working with a legitimate company can be risky and turn out to be more expensive than other repayment options.

The Risky Business of Debt Settlement

When you settle your debt, you work out an agreement with your creditor to pay off your debt for less than what you owe. Debt settlement companies manage those negotiations for you. They may even ask you to set up an escrow-like account for you to send in payments. By law, they cannot charge any upfront fees and have to clearly inform you about all fees and payments. But, if you make just one payment under one of their settlement agreements, you may be on the hook for all fees related to the program, even if you have not paid off all your debts.

Debt settlement agencies cannot guarantee the outcome of a negotiation. In fact, your creditor may refuse their offers. And if you stop making payments on your debts while working with a debt settlement company, which is what some debt settlement companies advise, you will start accruing late fees and interest and could even face collections or a lawsuit. All that, in addition to a dramatic negative impact on your credit.

Another thing to keep in mind is that any forgiven debt greater than $600 is considered taxable income. So, be prepared to receive a 1099-C form to file with your taxes if your forgiven debt meets that criteria. When you add the company fees and any potential taxes, a debt settlement may not be saving you as much as you would have hoped.

Your Debt Relief Alternatives

Depending on how much you owe and your current status with your creditors, you may have other debt relief options. You can try nonprofit credit counseling as a way to connect with a financial counselor who can review your situation and offer free or low-cost advice to help you create a debt repayment strategy. Another option is to settle your own debt, working directly with each creditor. It may take time and often more than one call, but you can contact your creditors and offer reduced payments. Be sure to offer payments that you know you can afford and always get any new agreements in writing.

Choose Wisely

If you decide to let a third-party debt settlement company handle the situation for you, make sure you work with a reputable institution. Do your research and look for reviews and complaints online about the company you plan to work with. Check with the Better Business Bureaus and contact your state attorney general and consumer protection agencies like CFPB to determine if there are any complaints or enforcement actions against the company. They can also help you find out if the company is allowed to operate in your state and meet the license requirements. Be aware of red flags such as upfront payments and a failure to disclose fees.