If you’re thinking about working with a debt settlement company to negotiate or settle your debts, there are some essential questions you should ask them before you sign up that can help you determine if the settlement company is legitimate and if they are the best option for helping you.
First, though, a quick explainer of what debt resolution is.
What Is Debt Resolution?
Also known as debt negotiation or arbitration, debt resolution allows for a debtor (you) and your creditor(s) (whoever has extended credit to you) to settle your debt for an agreed upon, lesser amount. Your payments are not made to your creditor(s), but instead to the settlement company, which usually holds the payments until all of your accounts are in default (creating settlement leverage).
During this time, your credit rating also goes down significantly due to the defaults on payment, especially if you were already behind on payments prior to the debt settlement company getting involved. These defaults will appear on your credit reports for seven years, but some people prefer this settlement option to bankruptcy.
Here’s where to start your conversation to see if the debt settlement company is on the up-and-up. If you encounter any one of the following red flags, it’s a good idea to consider another company.
1. What are your fees?
Settlement firms cannot charge up-front fees based on FTC rules, and your first fee cannot be charged until a debt is settled. If you do not get full written disclosure listing your expected fees, consider that a red flag and seek another settlement firm to help you with your debt.
2. How long have you been in the debt settlement business and how much debt have you settled?
Many companies don’t settle much debt at all, and young companies have very little experience. Debt relief rules require that companies base claims on all consumers who have enrolled in their programs and not just a few of their best examples when describing their results. If the company cannot provide proof of their experience – red flag!
3. Can you stop my creditors from calling me?
It is not possible to stop all creditor calls. If a debt settlement company says they can – red flag!
4. Will you be making monthly payments to my creditors?
Settlement companies do not make monthly payments to your creditors. If they claim to do so or if they give you the impression that they do – red flag!
5. Can I get sued?
The answer to this question is “yes;” it is a possibility. If they say anything to the contrary – red flag!
6. Will debt relief have a negative effect on my credit report?
The only honest answer to this question is “yes.” All debt relief programs will have a negative impact on your credit reports and scores. If they say anything to the contrary – red flag!
7. When can I expect my first settlement?
The settlement firm should tell you when your first settlement is expected, based on your creditors and the amount of money you are able to save to settle. The longer it takes to settle, the greater your risk of being sued. If it’s longer than 12 months – red flag!
8. How are you calculating my estimated savings?
If a company estimates you will save, say 50% of your debt by negotiating, they must base that estimate on the total debt you settle, including any fees or interest that accrue after you enroll in the program. In addition, they must also include the cost of the fees you’ll pay before calculating savings. Any firm that fails to provide a full disclosure of estimated savings – Red Flag!
9. Can you tell me exactly how long this will take and exactly how much this will cost?
Debt settlement is not an exact science, and you should not expect a firm to be able to predict exactly what will happen with your debts. However, under U.S. debt relief rules, the settlement firm must give you a reasonable estimated time frame based on your debts and how much you are able to save. If a firm does not provide this disclosure – red flag!
10. Are there tax consequences I should be made aware of?
The correct answer is always “yes.” The IRS considers forgiven debt to be taxable income, though you may be able to get the taxes waived if you can show the IRS you are insolvent. The company should adequately explain this. If not – red flag!
11. Who is holding my money while I’m waiting on a settlement?
Your funds should be held at a third party escrow company in an insured account. This account must be under your control, and you should have the right to close the account and get your money back without penalty at any time. If the company tells you to save your own money or to send the funds to them – Red Flag!
12. Are you being paid a commission?
Commissioned salespeople may stretch the truth or leave out vital information to make the sale. If they say they’re on commission – possible red flag!
13. When will I hear from you next?
A reputable settlement firm should keep you in the loop and pass along regular updates on the status of negotiations with your creditors. Anything less – red flag!
14. Are there other alternatives to debt settlement?
A legitimate debt relief firm will not discourage you from consulting with a reputable credit counseling agency to find out whether you may be a good candidate for a Debt Management Plan (DMP). They also will not discourage you from consulting with a bankruptcy attorney to learn about that option. If a company discourages you from exploring other options first – definite red flag.
This article has been updated. It was first published November 1, 2010.