You have probably come across ads by companies offering to settle your credit card bills for pennies on the dollar claiming that their services will cut your bills and save you thousands of dollars. If you have already maxed out your credit card balances and are already drowning in credit card debts, these offers would sound like the very solution you need. Do these offers sound like a scam? Or, can debt settlement firms really help you reduce your debts?
How does a debt settlement firm work? The debt settlement firms operate by collecting money from you every month. In the meantime, they do not pay your creditors. They merely put the money they collect from you in a trust fund. When you have already built up enough funds, they then negotiate with the creditors for a reduced payment and pay-off your bills in full. In theory, this is the way it is supposed to work
The reality, however, may be different.
Before you sign up, you need to consider a few things. First, you need to consider the fees being charged. The fees charged differ for each company. There is no industry standard. Typically, however, there is an initial set-up fee and a monthly fee that a client is supposed to pay month after month. This being an unregulated business, it is not unusual for clients to learn later on, that these firms together with the client’s money have vanished.
Clients make monthly payments to these firms thinking that these firms are already taking care of their debts. This is not so. You need to know that during all the months that the debt-settlement company is collecting from you and trying to build up enough funds to pay off the creditors, it does not settle anything at the beginning. In the meantime, all your credit card obligations remain unpaid, the unpaid bills are still affecting your credit scores and you may still continue to get collection calls from your creditors.
There are also usually high dropout rates from clients before the company reaches a settlement with their creditors. Let’s say, for example: that a client owes $20,000 in credit card debts. Assuming that a debt settlement firm intends to settle that $20,000 debt at 50% off or at $10,000; and, assuming also that a debtor pays $500 a month into the trust fund of the debt settlement firm, it will take 20 months for that $500 monthly contribution to reach $10,000. During those 20 months when the firm is not doing anything on your debt, the debtor still pays a monthly fee to the firm in addition to the $500 a month payment accumulated in the trust fund. Note that while your fund is accumulating for the next 20 months the debt settlement firm does nothing to reduce or cancel your debt. After 20 months, the firm may indeed be able to settle the debt for $10,000 but chances are the lender will not even wait for 20 months without doing anything. Chances are, the lender will initiate a collection suit in court long before 20 months. At this time, the debt settlement firms cannot do anything, as they are not authorized to practice law in a collection lawsuit. Thus, clients end up in exactly the same place they were before …… with unpaid debts and a collection lawsuit to boot.
You should also consider that debt-settlement has tax consequences. The amount forgiven by a creditor may be a taxable income. This is money that you now owe to the IRS. The problem with this is that if a client ultimately has to file for bankruptcy, it may put some clients in a worse situation. This is because tax debts may not be dischargeable in bankruptcy while the credit card debt was a dischargeable debt.
So, when is debt-settlement right for you?
Debt settlement would probably be a good solution for only a small portion of the population. You would probably be a good candidate for debt-settlement if you are ready to file for bankruptcy but do not qualify for a Chapter 7 filing (If a client qualifies for Chapter 7, most people would just file Chapter 7 and get a discharge on all the debts instead of only a portion of it in a debt-settlement). On the other hand, in a Chapter 13 filing a client will be obligated to schedule a payment of debts with creditors over a 3 to 5 year period. Hence, in these kinds of cases, debt-settlement may be a viable alternative instead of filing for Chapter 13.
Debt settlement companies do provide a service. However, it is in your interest to do the legwork first and find out if it is the right solution for you for the specific situation that you are in.
(DISCLAIMER: material presented above is intended for informational purposes only. It is not intended as professional advice and should not be construed as such. Rey Tancinco is a partner at Tancinco Law Offices, a professional corporation with offices in San Francisco, Vallejo, and Manila. The law office website is at: tancinco.weareph.com/old. Rey Tancinco can be contacted at (800) 999-9096 or (415) 397-0808 or via email at: attyrey@tancinco.com.)
