Debt Settlement Companies: How to Tell The Good From The Bad

a couple looks worried over debt - debt settlement companiesDebt settlement companies can be very useful tools when it comes to reining in an out-of-control debt spiral. Unfortunately, a number of individuals, some criminal and unethical, others just inept and inefficient, have set up companies that end up making a consumer's debt problems worse rather than better. In this series, WalletPop takes a look at the debt settlement industry, explaining how it works and talking to some of its players. This is the first installment in our debt settlement series.

When the holidays are over, there are bound to be some cash-strapped Americans who are going to take a long, hard look at their financial situation and ponder whether it's time to get some help from a debt settlement company.And maybe they should. While American households' debt has fallen for 10 straight quarters, according to the Fed, we're still overleveraged. The average American over 16 years of age is $10,168 in debt. But before they sign on the dotted line with one of these companies, they'd better do their homework first. Debt settlement companies often make the news, and not for good reasons. For instance:
We've written a lot at WalletPop about the evils of debt settlement companies and how it's best to stay away from them. Why? Because we've heard far too many anecdotes about debt settlement companies that have promised to help people, only to wind up getting their clients into more financial and legal trouble than they originally were. Or took their money then left them high and dry without offering any real help -- or any help at all.

Of course, not all debt settlement companies are just out to get your money, and sometimes, it can be a beneficial way to extract yourself from your crushing mountain of debt. For some who aren't willing to declare bankruptcy, in fact, it may be the only way.

Chris Viale, president of Cambridge Credit Counseling, a nationwide nonprofit debt counseling service, points out that there are basically three options somebody has if they're buried under a mountain of debt: "They can continue to struggle on their own, they can file for bankruptcy, or they can go into an alternative plan."

That alternative plan could be one of several further options. For instance, you could try to get a low-interest consolidation loan to pay off your debt. Chances are good, however, that if you're currently under a pile of debt, you're not going to be able to qualify for a loan.

You might also check out a credit counseling service, which will work to get the interest rates on your debts lowered, which will in turn lower your monthly payments, thus slowing your debt from going further out of control and making it a little easier for you to manage.

Or you might go to a debt settlement company for help. Instead of focusing on getting your interest lowered, they'll work with your creditors to help you severely reduce your balance -- taking you from $12,000 in debt to a more manageble $7,000, for instance -- which you then either pay off all at once or in installments.

Just why do people end up working with a debt settlement company over the other options? For one thing, Viale observes, a credit counseling nonprofit service can only get those interest rates so low and your monthly payments may remain too high for you to be able to realistically have a chance of paying off your debts. And you may not want to declare bankruptcy. After all, depending on how you feel about it, declaring bankruptcy may be a moral failing, or you may feel it would ravage your credit score and credit history, given that bankruptcies stay on your credit history for seven to 10 years, depending how you file.

With a debt settlement company, you're still going to pay off your debts -- you're just going to try to get the companies to which you owe money to agree to lower the total amount of debt you owe.

Because the amount of money you're dealing with is likely significant, exactly what a debt settlement company is able to do for you varies widely, it's critical that you thoroughly check out a company before you start working with it. Otherwise, you can blunder into using a debt settlement company that only makes your situation worse -- much worse.

For instance, some of these companies charge hefty fees and tell customers that everything will be handled by the debt settlement service. But nothing's actually handled, so customers go into even more debt. By the time they realize how bad things are, they've paid a ton of money to a business that's doing next to nothing for them.

Before you sign up for anything, here are a few signs to watch out for when you approach a debt settlement company. "In general, there are two tip-offs when you first talk to a debt settlement company," says Theodore W. Connolly, a bankruptcy lawyer and the co-author of The Road Out of Debt. The first, says Connolly, "[is] the upfront fee, which should be minimal, and the second is the amount of time they talk to you about your situation."

How much of an upfront fee should you expect to pay? "Anything under $75 is considered reasonable," says Viale. "The credit cards, the regulators -- that's generally their benchmark, where they say that it's unreasonable to charge someone who is having money problems over $75 to fix them."

That's for nonprofit debt settlement companies. If it's a for-profit firm, the debt settlement company isn't allowed to charge any upfront fee.

Unfortunately for the ethical companies out there, there have been plenty of debt settlement companies that have weasled figures well into the thousands of dollars from their "customers," putting a black eye on the industry.

As for how much time a company should invest while talking to you, Viale says, "If it's a good debt settlement company, they'll take the time to do an assessment to determine if you should go through bankruptcy, or go to credit counseling, or just pay down the debt on your own."

According to Connolly, if your initial meeting with a representative from a debt settlement company is less than an hour, something's probably wrong. Or if the person you're talking to doesn't give you their full attention, that's another sign the company isn't taking your situation seriously.

The scary part is, if you're at the stage where you're meeting with a debt settlement company, you're probably pretty desparate and are willing to believe whatever you're being told. And a crook doesn't usually act like a crook. In fact, it's usually just the opposite. A representative of the company may well spend an hour putting together a budget for you and pretending they care about your well-being. But if a debt settlement company seems to be strong-arming you into signing up, or if it is making it all seem too easy, telling you that it's going to be your savior and make all your money problems go away -- start backing quickly toward the door.

So what will guarantee that you'll find a good, reputable debt settlement company? While there's no sure bet -- even checking with your local BBB isn't necessarily a foolproof plan, points out Viale, since so many debt settlement companies, especially the bad ones, are new and haven't had enough (or any) complaints yet -- there are still a few things you can do to help ensure you're working with a company that's on the up and up.

First, get on your computer and Google the company to get a sense of how long the business has been around. Is it years or just months? The longer its been in business, the better. You should also check for any comments made or complaints filed about the company. While even good companies are going to have some complaints, you'll be able to tell from the amount of them and the content just what type of problems people may have had with this company.

Then, when you've settled on one or two companies you think you might want to work with, call your state's attorney general's office and find out if they have any complaints on file about those companies.

It may be take some time and require some legwork, but so what? Better to waste a little of your time than a lot of your money.

Correction: This story was corrected on December 17. A previous version of this story said the upfront fee for debt settlement service is around $50 to $75 for for-profit debt settlement companies. But as of two months ago, for-profit debt settlement companies are no longer permitted to charge an upfront fee.

Geoff Williams is a regular contributor to WalletPop. He is also the co-author of the book Living Well with Bad Credit.

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