16 Aug Are “Debt Management” Programs a Scam?
You’ve seen the ads for “Debt Management Programs”–“Settle $10,000 in credit card debt for as little as $2,000!” But do they really work? Do they make sense? Or are they scams?
Yes, they work. But only rarely do they make sense. And as for whether they are scams…it depends on your definition of a scam.
First, what are they? A Debt Management Program generally has you stop paying your credit cards and instead pay them a monthly payment for a period of time, usually a couple of years, until they have a nice pot of money. Then, they work out a lump sum settlement with your creditors, often at a substantial discount from the original amount due.
“Sounds good,” you may say. “So what’s the problem?”
The problem is that the actual savings are pretty much smoke and mirrors. Here’s why:1. They don’t do anything that you can’t do yourself. Debt, particularly credit card debt, doesn’t stay with the credit card company for long. As soon as it goes into default (typically when it hits 90 days past due), it’s sold to a debt buyer for pennies on the dollar. The debt buyer then sends you a letter offering you a huge discount for a lump sum settlement of the account. You pay the amount asked (or negotiate an even lower amount), send a check, and the account is settled, all without paying the Debt Management Program a penny in fees.
2. You may have to pay 1099-C taxes on the amount of forgiven debt. So if you have a $10,000 account and settle it for $4,000, you’ll be issued a 1099-C and have to pay taxes on the $6,000 in “income” you received.
3. By the time the firm has been paid enough to work out lump sum settlements, the additional interest, overlimit fees and late fees charged between when things start and when there is a settlement usually are about the same as the “savings”.
4. The overwhelming majority of folks never stick with the payments for long enough, which means that the debt management program charges obscene fees for doing *nothing*.
5. Creditors trash the client’s credit and often sue; none of this is stopped during the payment period.
I have had clients pay tens of thousands of dollars to these companies and ended up with very little benefit, when for a fraction of the cost they could have filed for bankruptcy, stopped the calls, letters and suits, and moved on with their lives.
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