Should I Use a Debt Relief Company?

Last Updated: June 24, 2019
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Debt settlement companies, or what is sometimes called debt relief or debt adjusting companies, are third party businesses that attempt to reduce your overall debt by negotiating settlements with your creditors for a fee. How do they work, their benefits and risks and what are the best alternatives?

Many borrowers look to these companies if they feel like they are buried in debt and unable to make headway with paying it down. Debt relief companies can be helpful, but their services do come with huge risks. We will look at how the companies work, what the benefits may be, as well as the risks. We will also cover some alternatives to using a debt relief company.

Debt Relief Companies: How Do They Work?

Debt relief companies attempt to contact your creditors on your behalf to try to settle your debts for a fraction of what you owe. They charge fees for their services. Many times it is a percentage of the total amount owed. Some debt relief companies also have a monthly fee. In addition, many will request that you start making payments into a account that you control. This money will be used to pay off the debt once the company reaches a settled amount. The debt relief company may even advise you to stop paying on some of your debts.

If the company is successful with settling with or getting more favorable terms with one of your creditors, that is when you start paying the fee. By law, debt relief companies cannot request a fee upfront. You should get a written disclosure of all their fees. There is no guarantee that they will be able to settle any of your debts. Many debt relief companies require that you have a certain minimum amount of debt before they help you. Sometimes going through their program can take years.

Benefits

The biggest benefit of using a debt relief company is that you end up paying less than what you originally owed creditors, even after fees are paid to the debt relief company. One of the well known debt relief companies in the market, National Debt Relief, states that they save borrowers 30% of the amount owed after fees. That is a significant savings and may be the boost you need to get back on your feet.

Another benefit is that you will have professionals looking out for you and doing the legwork to settle your debts. This will save you time and headaches. They understand what is needed to settle debts and in many cases already have relationships with creditors that you can use to your advantage. The debt relief company understands the process and the type of communication it takes to settle debts.

Risks and Drawbacks

There are some big risks and drawbacks associated with using a debt relief company. One drawback is that it is not cheap. National Debt Relief claims that they save you 30% of your debts after fees and that they normally settle debts for 50% of the amount owed. That means it costs you 20% to settle that debt.

For example, if you have a $10,000 credit card bill you are struggling to pay off, the debt relief company will settle it for $5,000 but charge you $2,000 for doing so. That is a big fee and is typical of the industry norm.

The other big drawback is that your credit will take a beating. If you already have bills in collections that you haven’t succeed to remove, some debt relief companies will ask you to stop making payments on those debts. This will create delinquent trades lines on your credit and your credit score will drop. Future creditors will see those settled debts on your credit report for years to come, which will make it difficult for you to secure new credit. It can take years to repair the damage of settled debts on your credit report.

Following the advice to stop paying some debts comes with an additional risk. There is a possibility that the creditor may not settle even when working with a debt relief company. If the creditor is unwilling to settle, not only are you deeper in debt, you will have late fees and other penalties added to your debt. Creditors are under no obligation to settle debts and if the debt relief company cannot settle, you will find you owe more money and have a worse credit history.

Another potential drawback is that the creditor issues a 1099 for the amount of debt discharged. That means you may have to pay taxes on the amount of debt forgiven. Because you did not pay it back, the government considers that money as income and requires that you pay taxes on it.

Going through this process will also not stop the debt collector from calling you and sending letters. They will still try to collect on your debts as you go through this process. There is no relief from the hounding of creditors, and in some cases creditors will seek legal action..

Debt Settlement Companies – Alternatives

Since there are so many drawbacks associated with using a debt relief company, such services should be considered as a last resort. Below are a few actions you can take before seeking out a debt relief company to improve your situation. Each provides a brief explanation, including their respective pros and cons. Be aware that each of these options requires your further research before implementing them.

  • Debt Management Plans – Plans administered by credit counseling that work with your creditors to lower rates and/or extend terms to help you pay off your debts.
  • Debt Consolidation – If you still have ok credit, you can apply for a consolidation loan. This is when you pay off many debts with one loan. Depending on the type of loan you apply for, you may get a fixed payment over the life of the loan. This is different from many credit cards, which can change anytime.
  • Go It AloneYou can negotiate your debts yourself. You will still experience many of the risks of settling debts, but you will not have to pay a 3rd party. You can save money this way, but you will need to be diligent and patient as it takes a lot of writing back and forth and negotiating with your creditors.
  • Non-Profit Credit Counseling – A counselor will review your financial situation including your debts and make suggestions about how you can improve your finances.
  • Bankruptcy – If you suspect that eliminating 30-50% of your credit card debt still will not help you financially, bankruptcy may be an option. Bankruptcy can either totally restructure how you pay your debt or eliminate your debt, depending on what type you file for. You should consult a bankruptcy attorney if you are thinking of taking this route.

What to Look For

If you do decide to move forward with a debt relief company, there a few things to consider in order to find a reputable company. You want to look for a company that has been around for a while. Choose one that has a good website, clearly laying out the services they provide. They also will list the fees they charge so check to make sure they are competitive with other companies – usually in the 18-25% of debt settled range. They should be able to reduce your debt by around 30% after fees. They should never ask for money upfront before they render any services. You will also get disclosures upfront and should review them carefully. Be wary of any guarantees.

Many debt relief companies only work with credit cards or medical bills, so if you have other types of debts make sure you look for a company that will address those specific debts for you. The company should be easy to reach. Also many debt relief companies are accredited by American Fair Credit Council (AFCC) and the International Association of Professional Debt Arbitrators (IAPDA). Also. always check the Better Business Bureau reviews.

Conclusion

Using a debt relief company should be considered as a last resort, just short of bankruptcy. There are many risks associated with using debt relief companies, and it is expensive.

If you are already considering bankruptcy or are unable to file bankruptcy for some reason, debt relief may be the way to go. Make sure you research the company and understand the process, including how long it may take. Understand that there are risks and it may take years for your credit scores to recover.