Debt Settlement Agencies: For Most, a Trap to be Avoided

30 May Debt Settlement Agencies: For Most, a Trap to be Avoided

In the past several years, there has been dramatic growth in the visibility of so-called debt settlement agencies. These are firms which advertise their supposed ability to “cut your credit card payments in half,” or promise they can “settle” your debt for only a small portion of what you owe — without filing bankruptcy.

This sounds too good to be true, and for most, it is not true at all. While debt settlement agencies might perform a valuable service for some people, all too often those unfortunate enough to fall for such high-sounding promises end up disillusioned and out of money.

Debt settlement agencies start out by pressuring the consumer to stop paying his or her credit card payments. This allows the consumer to divert the funds previously used for monthly credit card payments to the agency, which supposedly will accumulate the funds in an account, to be used later to make substantial offers of settlement to the credit card companies to which the consumer is indebted. It almost sounds like a reasonable plan, which no doubt accounts for the appeal of debt settlement.

However, what the agency fails to mention until later, when it may too late for the consumer to back out, is that the agency will charge a hefty fee for its services, often amounting to 25% to 50% of the amount to be paid out in settlement. Worse, this fee is often assessed upon the consumer’s payments to the agency first, as the payments are first being made to the agency.

This means that in reality, the consumer’s funds are being entirely consumed by the agency for its fees, at least in the beginning, rather than having the funds accumulate to be used for settlement. Additionally, the fees are usually nonrefundable, so that the consumer will lose all the payments made if he or she changes his or her mind about participating, or decides to file bankruptcy.

The most unpleasant surprise is that if the debt settlement agency actually does succeed in settling the consumer’s debts, income tax usually must be paid on the amount of the debt forgiven. For example, if your credit card debts total $50,000, and if a settlement of $25,000 is obtained, income tax must be paid on the $25,000 worth of debt which is forgiven.

Assuming that the consumer is paying one-third of his or her income in state and federal taxes, an extra $8,333 worth of income tax will have to be paid on the $25,000 in debt forgiveness income. For many, this additional income tax dramatically reduces the benefit of the settlement.

If you have too much credit card debt and are considering debt settlement, remember that the agency is not able to do anything you cannot do yourself. After all, you can pick up the telephone and make an offer of settlement just as well as anybody else can. Make your decision about this important matter only after investigating all your options, including talking with a lawyer about what would be the result if you filed bankruptcy.

Some states such as Kansas have outlawed most consumer debt settlement. Check with your state’s Attorney General Consumer Protection Division or the consumer finance regulatory agency to know if you reside in one of them.

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Craig W. Andresen is a consumer bankruptcy lawyer in Bloomington, Minnesota, with 22 years’ experience in consumer and small business bankruptcy cases. He is the Minnesota chair of the National Association of Consumer Bankruptcy Attorneys, and is a member of the Minnesota State Bar Association’s Bankruptcy Section. Mr. Andresen lectures often on the topic of consumer bankruptcy at local and national legal seminars.
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