I recently received a phone call from a friend of mine. He was stressed out, confused and scared. He recently went through a divorce that resulted in his accumulating more than $60,000 in debts. As if the events leading up to the divorce weren’t overwhelming enough, he’s now dealing with the mounting pressure of trying to make payments on this new debt in addition to paying the rest of his bills and expenses, eating and having a life.
The pressure was getting to him. Things were tight! He needed some wiggle room in his budget and he needed it fast. He thought he found the “magic pill” to his problem when he saw a commercial on television offering debt negotiation services. The pitch was: “Cut your debt in half! Pay off all your unsecured debt in under five years with minimum payments! Don’t trash your credit report by filing bankruptcy! Allow our law firm who specializes in ‘debt settlement negotiations’ to work on your behalf. Never deal with a creditor or collection company again!”
The 60-second commercial was still running when he picked up the phone and dialed in. The representative who answered the phone told him everything he wanted to hear. He was told that his $60,000 unsecured debt balance would be settled for approximately $42,000 in five years or less. He was told that his monthly payments on this debt would be $736 a month. He was currently paying approximately $1,364 a month. The idea of saving $628 a month and paying this debt off in five years had him salivating at the mouth. He was told that his credit would remain in good standing because a law firm was representing him.
He was on board immediately. He had them fax over the paperwork. He signed the agreement and faxed it back to them along with a voided check so that they can do a direct debit from his checking account for $736 a month. Nonetheless, he had some suspicion. He decided to call me to see if he’d made a good decision.
When I learned that he was working with a debt negotiation company, I told him that he has to be careful for there are a lot of scam artists who pose as debt negotiation companies. They make claims that they can settle debt for you. They request an initial deposit of a couple of thousand dollars. After they receive the check, you never hear from them again. The hairs on his arms stood straight as he listened intensely to me. He shared the details of the program he signed up for. I told him that there were some legitimate debt negotiation companies out there but he’ll pay a stiff fee for their services and his credit will be trashed. I went on to share the details of what I was sure they did not tell him.
Credit trashed. In order to get a settlement on your debt, you have to be severely behind on your account. As a result, they’ll discourage you from making payments on your accounts. Instead, they’ll ask that you send them a check every month. They will not use the money you’re sending them to make payments on your debts. They’ll set up a trust account on your behalf. When you have accumulated enough money in the trust account, they’ll negotiate settlements on your debts one debt at a time. During this process your credit report will report major delinquencies on the accounts you included in this plan, ultimately trashing your credit.
Fees, fees and more fees. You’ll pay a non-refundable retainer fee up to 10 percent of the balance of the account you included in this program. Since you have $60,000 in debt, your fee will be $6,000. You’ll pay a monthly maintenance fee of approximately $65 a month or $780 a year for the privilege of them managing your trust account. You’ll pay fees to them and your bank if a check you sent to them bounced. You’ll pay an overnight fee or a wire fee when money is sent to a creditor to settle on an account. Worst of all, you’ll pay a settlement fee of up to 33 percent on the portion of the debt they negotiated to be waived. In other words, if the balance on your debt is $1,200 and they negotiate a settlement for $600. They’re going to charge you a fee of $198.
Cancellation of debt is a taxable event. The IRS considers any debt you owe that was cancelled or forgiven as taxable income unless an exception such as bankruptcy applies. In the year that a settlement is reached on your debt, both you and the IRS will receive a 1099-C disclosing the amount of the debt that was cancelled or forgiven. You’re required to include the amount that was as income on your tax return—potentially increasing your tax liability.
Once you factor in fees, taxes and the high interest rates you’re likely to receive in the future because of having spotty credit, the question becomes, was there a benefit? You don’t need to pay an attorney exorbitant fees to stop making payments on various credit cards, trash your credit and negotiate settlements. Not that I recommend it, but anyone can pull that off. If there were a benefit to debt negotiation companies, it would be the fact that they’ll deal with debt collectors on your behalf.
Fact remains, they can’t guarantee you a settlement nor can they guarantee that the creditors won’t take you to court.
(Mortgage and money coach Damon Carr is owner of ACE Financial. Sign up for Damon’s FREE online e-newsletter at www.allcreditexperts.com. Damon can be reached at 412-856-1183.)