Debt Settlement Plans May Put You Deeper in Debt

NEW YORK (MainStreet) — Though the average American household that carries a credit card balance from month-to-month owes more than $15,000 across all their cards, that doesn't tell the whole story. Many also struggle with medical debt and student loans, too. The promise made by debt settlement companies to have "half your debt written off" or to be "debt free in as little as 36 months" is a lifeline to financial freedom many consumers find hard to resist.

But debt settlement companies may be over promising and under delivering, according to the nonprofit Center for Responsible Lending.

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First, consumers are often hard-pressed to make the distinction between for-profit debt settlement companies and non-profit debt management plans offered by credit counselors.

"[A] credit counseling agency gets an up-front agreement from the consumer's creditors to allow the consumer to repay her debts over 3-5 years with modified terms, such as a significantly reduced interest rate and/or the elimination of late or other penalty fees," the CRL says in its "State of Lending" report.

However, debt settlement companies take an entirely different approach.

"Debt settlement is inherently a risky venture: in order to enroll into debt settlement programs, consumers are required to default on their debt which often results in fees, increased interest rates, and sometimes even lawsuits from creditors," the CRL says.

Instead of paying down debts directly to the creditor, consumers using a debt settlement service are instructed to stop making direct payments while the provider negotiates with the lender to reduce some or all of the amounts owed. The consumer makes deposits into a third-party account for future payments to be issued.

However, not only can fees range from 20% to 25% of the total debt, but some creditors refuse to negotiate with debt settlement companies. And when the payments stop, the account becomes delinquent, triggering penalty interest rates and late fees – ultimately impacting the individual's credit score.