If you’re thinking about working with a debt settlement company to negotiate or settle your debts, you should ask them some essential questions before you sign up. Getting these answers can help you determine if the settlement company is legitimate and if it is the best option for your financial situation.
Discover more about debt settlement and other resolution options below. Then, answer these questions before you sign up for any debt settlement service.
What Is Debt Settlement
Also known as debt negotiation or debt resolution, debt settlement means your creditors have agreed to accept less than the full amount you owe them. Most creditors will not accept settlement offers if it appears you can pay the full amount, however. So debt settlement often requires you to stop paying entirely. Instead, you make payments to the settlement company, which holds the payments in escrow until you have enough to offer a lump sum and negotiate a lower total payment.
Risks of Debt Settlement
During this time, your credit rating will likely go down significantly due to your defaults of payment—especially if you were already behind on payments. These defaults will appear on your credit reports for seven years, but some people prefer this settlement option to bankruptcy. You may also continue to accrue late fees and other penalties on these accounts, increasing the debt you are obligated to pay.
〉Learn more: How Debt Relief Affects Your Credit
You will also incur fees required by the debt settlement company, including fees to maintain the account your funds are held in—though you should maintain ownership of the funds and any interest that accrues. You may also be taxed on any forgiven debt.
Debt settlement is generally not an option for debts like a mortgage that can be foreclosed on or car payments on a car that can be repossessed. Student loans are also generally not settled by debt settlement companies. Debt settlement through a company, based on our research, will likely take between two and four years.
Due to the potential extreme negative effects to your credit, debt settlement should generally be considered a last resort.
Debt Settlement Alternatives
Debt settlement is different from debt consolidation, which is using one form of credit to bring multiple other debts under a single balance and account. For example, you might transfer the balances of three credit cards to a single card. You might also take out a personal loan to cover several smaller debts. Debt consolidation doesn’t get rid of your debt, but it can make it more manageable.
〉Learn more: How to Consolidate Your Debt
〉Learn more: Debt Consolidation Loans
〉Learn more: Balance Transfer Credit Cards
Debt Relief Questions
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. Are you an IAPDA-certified debt consultant?
This has more to do with the individual you are talking to than the company as a whole, but you do want to make sure that you are talking to a debt consultant rather than a salesperson. IAPDA certification requires training in debt solutions and credit counseling.
Red Flag: If the person you are talking to is not a debt consultant, it may be a salesperson who is more concerned about making a sale than helping you with your debt.
2. Are you being paid a commission?
Similarly, commissioned salespeople may stretch the truth or leave out vital information to make a sale.
Red Flag: If they say they’re on commission, you may want to do additional research into their claims rather than taking their word for it.
3. 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—in fact, some large firms have been sued because they have settled so little of the debt brought to them—and young companies have very little experience. Debt relief rules require that companies base their claims on all consumers who have enrolled in their programs and not just a few of their best examples when describing their results.
Red Flag: If the company cannot provide proof of its experience, or its success rate sounds too good to be true, do some independent research.
4. Are you a member of the American Fair Credit Council?
American Fair Credit Council membership is not mandatory, but AFCC members follow strict industry standards. Members are regularly audited by the AFCC and a third-party firm to ensure they are following those standards.
Red Flag: If a company is not a member of the AFCC, ask them why. The only reason not to be a member is if it doesn’t want to be held to higher standards.
5. Are you licensed to do business in my state?
Some states have specific restrictions and requirements for debt management companies. A reputable debt settlement company will understand the specific regulations of your state.
Red Flag: If the company cannot confirm that it is licensed to do debt settlement in your state, it might be time to move on.
6. Will all of my creditors work with your company?
Not all companies will work with debt settlement companies. In many cases, debt settlement companies will wait until your creditors charge off your debt and sell it to a debt collection agency, which the debt settlement company can then work with. Once your debt is transferred to a collection agency, you may not be able to negotiate a good rate, and you may be more likely to get sued. In addition, debt negotiation is generally not an option for certain loans like a mortgage or car loan.
Red Flag: If the company claims that all of your creditors will work with them, that could be a red flag. Waiting for debts to charge off could end up costing you much more in the long run. At the very least, the company should explain the charge off process and its risks to you.
7. 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. Your fees should also be structured as a percentage of the debts that are eliminated—not the debt you begin with. Most companies will also have setup fees as well as monthly fees and a fee to maintain your funding account, all of which should be clearly explained.
Red Flag: If you do not get full written disclosure listing your expected fees, or if the company claims there are no fees, it may be hiding something.
8. 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.
Red Flag: If the company doesn’t give you an expected time frame—or says it can give you an exact time and cost—consider it a major red flag.
9. 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.
Red Flag: If it’s longer than 12 months, the company is not taking your best interests into account.
10. How are you calculating my estimated savings?
If a company estimates you will save 50% of your debt by negotiating, it 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, it must also include the cost of the fees you’ll pay before calculating savings.
Red Flag: Any firm that fails to provide a full disclosure of estimated savings shouldn’t be trusted.
11. Will you be making monthly payments to my creditors?
Settlement companies do not make monthly payments to your creditors. Instead, it should settle debts with lump sum payments taken from an account held in escrow in your name.
Red Flag: If the company claims to make monthly payments or if it gives you the impression that it does, then find out exactly how they conduct their business. This is not how debt settlement generally works and is cause for you to be concerned about pursuing business with that company.
12. Who is holding my money while I’m waiting on a settlement?
Your funds should be held by 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.
Red Flag: If the company tells you to save your own money or to send the funds to them, you should move on and continue to research different companies.
13. Can I get sued?
Debt settlement carries some risk, and you may get sued for nonpayment. A reputable debt settlement company will do whatever it can to make sure this doesn’t happen, but it cannot guarantee that you will not be sued.
Red Flag: If the company does not admit to you that debt settlement always carries some risk of being sued, be aware that you are at risk regardless of what the company tells you.
14. Will debt relief have a negative effect on my credit report?
Because they are based on nonpayment of your debts, all debt relief programs will have a negative impact on your credit reports and scores.
Red Flag: If the company says anything to the contrary, you should not trust it.
15. Are there tax consequences I should be made aware of?
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.
Red Flag: If the company does not disclose the potential tax consequences or claims there are none, they are not a company you should consider working with.
16. 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). it also will not discourage you from consulting with a bankruptcy attorney to learn about that option. You can do debt settlement yourself, and a reputable company will tell you so.
Red Flag: If a company discourages you from exploring other options first, this company does not have your best interest at heart. Debt settlement companies are ultimately in the business of making money, but it should still be able and willing to explain your options to you.
17. 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.
Red Flag: If the company cannot tell you when to expect an update, you may not get any updates at all.
Research Your Debt Resolution Options
If settlement is the right choice for you, take time to find reputable lenders to work with. If you’re looking for alternatives to debt settlement and the potential negative consequences to your credit score, find out more about debt consolidation loans and balance transfer options instead. This is a big decision, so make sure you have done your research and feel comfortable with your decision.