The Ugly Truth About Debt Settlement Companies and Why Bankruptcy Is Often a Better Option

Why Bankruptcy Is a Better Option than Debt SettlementThe National Association of Consumer Bankruptcy Attorneys (NACBA) recently published a consumer alert report entitled “The Debt Settlement Trap: The #1 Threat Facing Deeply Indebted Americans,” which detailed the stories of debt strapped consumers who have fallen prey to the numerous scams peddled by so-called debt settlement companies. You’ve probably heard their claims on TV and on the radio a million times. Debt settlement companies that promise to settle your debts for pennies on the dollar and to get you out of debt without filing bankruptcy. Their commercials usually feature a handful of earnest folks who claim the debt settlement company saved them from the supposed stigma of bankruptcy by negotiating with their credit card companies and bill collectors. Their commercials bombard the air waves with the message that bankruptcy is somehow morally wrong, and the debt settlement companies offer a more honorable alternative than filing personal bankruptcy.

What they don’t tell you about is the debt settlement industry’s abysmal failure rate. According to a 2010 Government Accountability Office report compiling data from the Federal Trade Commission and 43 state attorneys general, less than ten percent of consumers successfully complete debt settlement programs! Nor does the debt settlement industry explain in their commercials that creditors can and frequently do accelerate their collection efforts once a person enrolls in a debt settlement program. That means they step up their campaigns of harassing phone calls, and will eventually sue the consumer because they have been instructed by the debt settlement company to stop making payments directly to their creditors altogether. Yes, the credit card companies can and do sue you in spite of the fact that you’ve enrolled with a debt settlement company. They then obtain judgments that include all the interest, penalties, and now attorneys’ fees that they’ve racked up against you while the debt settlement company was supposedly negotiating with them.

And once a credit card company or other creditor gets a judgment against you, they can then pursue a range of nasty new collection efforts—from garnishing your wages to placing a lien against your home.

The problem I have with debt settlement companies is the fact that their ads are misleading. They’re simply not being straight with people. Not only do they fail to inform debt strapped consumers that their failure rate (of successfully negotiating settlement of all a customer’s debts) is close to 90%, but they likewise fail to explain how their programs work, or the percentage they charge for their lame efforts, or the fact that they often leave their customers in a worse position than they were in before they enrolled in the debt settlement program. That’s because while the debt settlement company is collecting large payments from their customers every month, earmarking a substantial portion of that for themselves—they are mostly for profit companies after all—the consumer’s debt burden is ballooning due to increased interest, late fees and penalties. Additionally, every month that goes by while the consumer is enrolled in the debt settlement program (and not making payments directly to their creditors), their credit score is rapidly destroyed. And if the consumer is like the vast majority of people who enroll in debt settlement, who end up getting sued anyway or who drop out because they can’t afford the exorbitant monthly payments and fees that the debt settlement company is charging them, then he or she ends up far worse off with even bigger credit card balances, no settlement, worse credit, and often a judgment and wage garnishment. Lastly, the debt settlement company commercials fail to inform consumers that if they do actually succeed in settling any debt, then the consumer will be liable to pay taxes to the IRS on that settled debt as though it were income—unless the consumer can prove to the IRS that he or she was insolvent at the time the debt was settled (and retirement savings are included by the IRS in that calculation of “insolvency”). As I’ve written here on this blog before, debts discharged through bankruptcy, on the other hand, are not taxable as income—no matter whether the debtor had any retirement savings at the time the debt was discharged.

So, the next time you hear a talking head on TV urging you to steer clear of bankruptcy and to enroll in a debt settlement program instead, remember this: there is already a legal way to free yourself from debts. One mandated by federal law that provides a range of powerful protections for the debtor—from stopping all collection activities, including lawsuits, to allowing one to actually remove judgment liens from one’s home—and that federal debt relief program is called bankruptcy.

If you can afford to pay some monthly payment toward your debts, but cannot pay them in full, there’s a program for that too. It’s called Chapter 13 bankruptcy. If you simply cannot make monthly payments on your debts and still cover your necessary living expenses, well there is a relief program for that situation too. It’s called Chapter 7 bankruptcy. And either path is a perfectly honorable, legal way to free yourself from debt and get a fresh financial start.

I’m a San Jose bankruptcy attorney. You don’t have to take my word that debt settlement companies generally do more harm than good. Go ahead and read these government and other reports about the abusive, often fraudulent practices of the debt settlement industry. And if you need relief from your debts, do yourself a favor and at least get a free consultation from a knowledgeable bankruptcy attorney before you sign a contract with one of those debt settlement outfits you see on TV.

This entry was posted in Bankruptcy Basics, Consumer Protection, Debt Settlement and tagged , , , . Bookmark the permalink. Both comments and trackbacks are currently closed.