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Debt Management Services: Buyer Beware

“Cut your payments in half.”
“Lower your monthly payments.”
“Consolidate credit cards into one low monthly payment.”

We’ve all heard it by now.  The ads for debt management services are on TV, radio and the internet.  These services are third-party companies that will work with your creditors, particularly credit card companies, to restructure your debt on your behalf.  Debt management services include credit counseling, debt settlement and debt consolidation loans.  The debt management services industry is growing fast - but “buyer beware”.  This industry is relatively unregulated (a few states are doing something) and fly-by-night companies are popping up everywhere.  This could be the next predatory lending fiasco.

Debt management services are for the person who can’t afford the monthly minimum payments, is missing or making late payments, or has collectors calling them.  Before you sit down with a debt management service company, you need to do a lot of research:

• Compare what the companies have to offer.  Particularly, will they work with you to develop a plan to eliminate your debt?
• Check the Better Business Bureau website to determine if there are any bad reports regarding the company.
• Do internet searches on the company to see if there are any critical articles about the company.
• Check with your state’s business licensing agency to see if the company has a business license to operate in your state.
• Check for industry accreditations such as the Association of Independent Consumer Credit Counseling Agencies or The Association of Settlement Companies.
• “Not-for-profit” does not mean trust worthy or better than “for profit”.  There has been a proliferation of “not-for-profit” debt management services companies and it has prompted the IRS and state agencies to investigate their status.

Once you have decided on the company there are several precautions you should take. First, demand things in writing - particularly fees, guarantees/promises and types of services being provided.  Second, read and understand what you are signing – don’t sign any document if you don’t understand what they mean.

Some debt management services companies are targeting people who are unhappy with new credit card terms.  If you are current on your payments, but are upset that your credit card company just raised your interest rate/finance charges, do not use a debt management service.  Call your credit card company and tell them that you are not happy with the revised fees and plan to cancel the card.  If they don’t agree to reduce your interest rate/finance charge then cancel.  Find a new card, but don’t fall for these debt management companies’ sales pitch.

Credit Counseling Services

Most/Good credit counseling services will analyze your debt and income and develop a plan to eliminate or drastically reduce your debt.  After the plan is developed, the credit counselor will begin to negotiate with your creditors to change credit terms such as lowering interest rate/finance charges and/or possibly reducing your debt balances.  Credit card companies may only work with those credit counseling services that have some relationship with them – mostly a contractual relationship.

Once the credit card companies and credit counselor have settled on new debt structure/payment plan, you can begin making payments on the debt – typically a single payment to the credit counselor who will then forward the payment to the credit card companies.  Credit counseling services may lower your credit score.  But your credit score should not be a priority under these circumstances – what is important is digging out of the debt whole.

Credit counseling services usually charge an upfront fee such as a “set-up” fee which can range from $10 to $100, depending on the level of service provided.  Be careful, some companies charge huge upfront fees and some will take a fee out of the first payment you make.  This could be problematic because one more payment not going to credit card companies results in more late fees accruing to your account.  The important thing is that you ask and understand if they will keep the first payment.

Most credit counseling services are paid by the credit card company and that is how they make most of their money (interesting relationship?).  Typically, a credit counselor will retain a portion of your monthly payment as their fee.  Again, it is important to ask and understand what portion of your monthly payment the credit counselor will retain because that will impact how soon you can pay-down credit card balances.

A legitimate credit counselor will be realistic.  This process may have a negative impact on your credit history so don’t believe the hype if a credit counselor promises that your credit history will not be hurt.  A credit counselor should work with you on a plan to eliminate your debt in 2-4 years.

Debt Settlement

Debt Settlement companies are popping up everywhere.  This service is prone to fraud and deception.  The important thing to understand with debt settlement is how the process works.

A debt settlement company will negotiate, on your behalf, with credit card companies.  They try to settle for certain dollar amount.  This process can take several years depending on the amount of debt and number of creditors.

But before they start negotiating with your creditors, they have you set-up a “settlement account” in which you make monthly deposits/payments.  The debt settlement company holds these accounts.  The debt settlement process does not happen immediately because a credit card company is not willing to negotiate until an account is past due for a number of months – sometimes six months past due.  The credit card company does not stop charging late fees and interest/finance charges during this time period so a person can accrue huge amounts of late fees and finance charges on top of the credit card balances already owed.

Your credit history will suffer with debt settlement.  First, if you suspend payments to the credit card companies and instead pay into the “settlement account” this will result in credit card companies reporting no payments to credit bureaus.  Second, once a settlement amount is determined and paid, the credit card companies will report that the credit card accounts were “paid as settled” which is not good.

Debt settlement companies typically charge an initial set-up fee and a monthly service fee which can be taken out of your monthly payment to your “settlement account”.  These fees will impact how soon you will accumulate money in your “settlement account”.  If the monthly service fees are high then a very small portion of money will be saved for paying off the settlement which can prolong the process.

Research is absolutely required if you decide to use debt settlement.  Again, check with the Better Business Bureau website for complaints.  There is an accreditation association: The Association of Settlement Companies (TASC).  Make sure you get any guarantees, fees and services provided in writing and don’t sign anything until you understand what you are signing.

Debt Consolidation Loan

Debt consolidation loans can be deceiving.  Sure, it is nice and convenient to pay one payment instead of ten, but are you really saving any money on a monthly basis or in the end.

Before you decide on a debt consolidation loan you should itemize your debt payments and compare to the single monthly payment of the debt consolidation loan.  If your credit history is starting to suffer because of the huge debt load then you could end up paying a high interest rate or be denied a debt consolidation loan.

Debt consolidation loan is just replacing one debt for a bunch of debts.  If you have a problem with debt management, a debt consolidation loan is not going to help.

Other Alternatives

• Rip/cut them up (your credit cards) and negotiate on your own.  It doesn’t hurt to talk to your credit card companies.
• Home equity loan or line of credit.  But be careful because you are converting unsecured debt to secured debt which is usually not a good idea.
• Bankruptcy.  Some people may be carrying so much debt that the options discussed above may not be an option because their income is still not enough to make the monthly payments.

Two important things: first, we need recognize early on if we have a problem with our debt load and try to do something about it before the problem gets worse and it starts threatening our health, relationships and other valuable assets.  Second, if we can get out of a debt whole we have to make sure we don’t make the same mistake in the future.