Reduce your debt by 60 percent! Be debt-free in 12 months! The siren song of debt-settlement firms is harder to ignore these days, especially if creditors are knocking at the door. Tempting as the ads may be, debt-settlement firms can leave you in an even worse mess. Many are outright scams.
“If a company’s making big promises, it should raise red flags,’’ said Alison Southwick of the Better Business Bureau. “Getting out of debt is not easy.’’
Here’s what you need to know:
■ How it works. The premise is that debt-settlement firms negotiate with lenders to whittle down your balance. You pay a lump sum. Some firms promise to lower your debt by 70 percent.
A firm might charge up to 20 percent of what you owe - upfront.
The BBB lists all debt-settlement firms under its new “inherent problem’’ category, meaning it has concerns about the entire industry. Companies can apply to be removed from the category by demonstrating they deliver. No firms have been removed yet.
■ Better alternatives. There is no need to hire anyone. You can negotiate a settlement directly with your lender.
“They have a complete picture of your finances. They will know if you’re a candidate,’’ said Gail Cunningham of the nonprofit National Foundation of Credit Counseling.
Before you even reach that point, exhaust all other options. A negotiated settlement should be a last resort. If you feel overwhelmed, ask for a free consultation at a nonprofit credit counseling agency. You may be able to develop a budget that lets you meet your debt payments if you work with a counselor.
Or, a debt management plan may be in order. You and your lender agree to more manageable repayment terms, usually over a longer period. The credit counseling agency will probably charge a monthly fee of about $20 to work out a debt management plan. The plan will be noted on your credit report, but it won’t hurt your credit score.
You could also try negotiating a loan modification directly with your lender. A modification can include a lower interest rate, the elimination of fees, or a reduction of the monthly payment.
If you decide a debt settlement is your only option, call your creditor directly. Some credit card companies refuse to work with settlement firms.
■ Repercussions. Hiring a debt-settlement firm won’t stop the collection calls. Interest and financing charges can still rack up, and your lender might even sue you. The total amount of your debt is likely to grow if a settlement isn’t reached. And it usually takes about three years to complete a debt settlement. Clients typically can’t pay the settlement amount right away. So the debt-settlement firm will run interference while the client saves money.
A settlement will be on your credit report for seven years and can hammer your credit score.
Candice Choi is an Associated Press personal finance writer.