Costs of Debt Settlement

For a consumer deep in credit card debt, the promises made by debt settlement companies may seem like a ray of hope. When debt balances have gone up and you can no longer make your monthly payments, settling your debts for less than you owe can sound like a good way out. Besides, you know that much of your balances are fees and interest anyways.

Until you understand the costs of debt settlement, it may be difficult to comprehend how your decision might haunt you for years. The effects can be catastrophic.

Immediate Costs of Debt Settlement

The immediate costs of signing with a debt settlement company are measured by the upfront fees that you pay. Most debt settlement companies require substantial fees of 12-15% of your debt balances to be paid upfront.

The minimum upfront cost of a debt settlement plan is $995 to $1,200. If you owe more than $15,000 in debt, your upfront costs will be far higher. Compare that with credit counseling, where their programs normally limit upfront costs to $0 to $50. On $40,000 in debt, your debt settlement plan will normally require $4,800 to $6,000 to be paid upfront, before they will begin examining your case.

Debt settlement companies will take no action until their upfront fees have been paid and you begin to build a balance in your account. That means that your first 6-12 months of payments are just to pay the fees for actions that they make take in the future.

Recurring Costs of Debt Settlement Plan

You would think that the upfront costs would be enough to pay for the administration of a debt settlement plan. However, clients are also expected to pay monthly fees of $49 to $99. These fees are deducted from your account balance whether you make a payment or not.

If you withdraw from the plan in the first year as most of their clients do, you likely will lose almost all funds that you paid in without settling a single debt. Refunds are rare, and only partially paid in most instances.

Your total fees for the plan can run between 15% and 25% of your total debt. When you are trying to settle for 50% of what you owe, this can translate to a savings of only 25-35%. Suddently, the allure of debt settlement plans is less appealing.

Many debt settlement plans also charge a percentage of the “savings” which can further erode the forgiven debt.

Tax Consequences of Debt Settlement

Assuming that you are fortunate enough to settle a debt for half of what you owe, you might be surprised to learn that the other forgiven half is considered taxable income. Even if your income is fairly low, a large amount of forgiven debt could push you into a higher tax bracket.

Debt settlement companies rarely disclose this consequence, yet it can cost you hundreds or thousands of dollars in unexpected tax liabilities. Your savings of 25-35% can quickly drop to 0% to 25% of what you owed.

Your notification of your tax liability is made by Form 1099-C, which is filed by your creditor when they forgive $600 or more in debt. It could be many months later before you finally receive this bit of bad news.

Legal Action is Not Prevented with Debt Settlement Plans

Despite enrolling in a debt settlement plan, you have zero protection from legal action taken by one or more of your creditors. They are free to pursue normal collection activities, judgments, liens, garnishments and levies where permitted by state law.

If you think that your debt settlement company will protect you from legal action, think again. They will not represent you nor will they provide you with legal advice.

If you need legal advice, you will have to retain an attorney to represent you. If you fail to show up in court, a judgment may be immediately rendered against you. This could keep you from being able to pay your other bills, thereby causing another round of late fees.

Future Lending Costs Increase

For the next 7 years following your last settlement, it will be difficult to obtain new credit. Current accounts may cut your credit limits to reduce their risk exposure. Any new credit offers will carry higher interest rates.

These may not be concerns to you if you have decided not to use credit cards anymore. However, your bad credit will still haunt you in many other ways.

Car loans will carry higher interest rates. A $20,000 car loan could cost you an extra $3,000-$5,000 in interest. Your $200,000 mortgage might cost an extra $50,000 in interest. Your insurance rates also may be higher, unless you are fortunate to live in one of 5 states that prohibit the practice.

You can say goodbye to many of the job opportunities that require good credit. In times of high unemployment, you will be behind other qualified candidates who have better credit ratings, thereby making it exceptionally difficult to win the right job.

You may even find that deposits are necessary on accounts that you never needed them on before. A new cellular phone contract might require a $500 deposit. Basic utilities could require deposits. All of this can increase the amount of cash you need should you have to relocate.

In the end, the costs of debt settlement plans are so high that no rational person would agree to being at such a disadvantage. The truth though is that few of their clients research debt settlement pros and cons before they enroll with one of these rogue companies.