United StatesChange Country

Are Debt Relief Programs Too Good to be True?

Wondering how debt relief works? Learn more about debt relief programs, the risks and alternatives before you qualify for one.

By Megan Doyle | American Express Credit Intel Freelance Contributor

5 Min Read | November 06, 2019 in Money

 

At-A-Glance

Debt relief programs promise to help you get out of debt by negotiating with creditors on your behalf.

But they can be expensive or offer unsound financial advice.

Experts recommend considering alternatives before turning to debt relief.

In late 2018, total household debt in the U.S. reached $13.54 trillion—the 18th consecutive new quarterly high, according to the Federal Reserve.1 That may sound startling, and translate into future debt-servicing challenges for many Americans. But the fact is, financial crises can happen to anyone, at any time. The good news is that there are ways to manage—and often overcome—debt. Among the many strategies are debt relief programs, which aim to renegotiate your debt with your creditors. That might sound like a dream come true—but if you’re not careful, debt relief programs can make matters worse.

 

What is a Debt Relief Program?

Debt relief programs, also known as debt settlement or debt adjustment programs, promise to help you get out of debt by renegotiating, settling, or changing the terms of your debt with your creditor.2 If you have credit card debt, for instance, a debt relief company might be able to negotiate with your credit card issuer to reduce the total amount you owe. That’s sometimes called credit card debt forgiveness, but that term sounds better than it usually is—100 percent forgiveness is rare.

 

How Do You Qualify for Debt Relief?

To qualify for a debt relief program, you’ll likely need to demonstrate legitimate financial hardship. This means you won’t qualify if you’re just a month or two behind on your bills. You’ll likely have to be at least $7,500 in debt, otherwise creditors will have no incentive to negotiate, according to some debt relief companies.3

 

How Does Debt Relief Work?

First, you sign up with a debt relief company. If you qualify for a debt relief program, the company will attempt to negotiate with your creditors to let you pay off your debts with a lump sum that’s less than the total amount owed.4 

To build up that lump sum, debt relief companies typically require you to make monthly deposits to an independent savings account for as long as three (or more) years.5 In the meantime, debt relief companies will usually advise their clients to stop paying creditors.6  The idea is to make creditors begin to worry that you won’t pay at all, incentivizing some level of debt forgiveness since they’d rather get some payment over no payment.7

 

What's the Catch? Debt Relief Programs Can be Risky

According to the U.S. Consumer Financial Protection Bureau (CFPB), debt relief programs are notorious for offering unsound financial advice, being expensive, and being downright risky.8 Here’s why:

 

  • It might not work. Your creditor has no obligation to agree to renegotiate your debt. This means that even if you make your debt relief program’s required deposits and stop paying your creditors, your debt still might not be settled or renegotiated.
  • They can deepen your debt. Periods of non-payment can lead to late fees and more accrued interest, potentially leaving you more in debt than when you started.
  • Debt relief programs can hurt your credit. Missed payments are reported to the credit bureaus, harming your credit history. That information can stay on your credit report for years, possibly hindering your future financial opportunities.
  • Expensive fees are common. Debt relief companies can charge fees that might be as much as 20 percent of your total debt.
  • You could get sued. Your creditor can file a debt collection lawsuit against you if you stop paying your bills.

But don’t think you can avoid the taxman. The CFPB warns that if the debt relief company succeeds in having your debt forgiven at a fair price, whatever amount is forgiven might be counted as taxable income on your federal income taxes.

However, that’s not to say all debt relief programs are bad news. To weed out the good from the bad, the U.S Federal Trade Commission (FTC) recommends contacting your state Attorney General and local consumer protection agency to find out if the agency is licensed, and whether or not any consumer complaints have been filed about the company.9

 

Alternatives to Debt Relief Programs

Before agreeing to a debt relief program, the CFPB recommends looking into alternative solutions, like nonprofit credit counseling services. These counseling services provide educational materials, individualized financial counseling, and even debt restructuring services to help consumers get out of debt. And, a recent study shows they can be an effective strategy for addressing consumer debt. 10

The CFPB also recommends working directly with your creditors or debt collectors. By calling your lenders to explain your situation and discuss options, you might be granted a grace period, lower interest rates, or the option to join a program to help you pay off your debt without risking extra fees, lawsuits, or too much damage to your credit score.

You might also be able to reduce what you owe by consolidating your debt.

 

The Takeaway

If debt relief programs sound too good to be true, it’s because they can be—if you’re not careful. Since debt relief programs can be expensive or offer financial advice that could harm your credit score, the Consumer Financial Protection Bureau recommends understanding the risks and considering alternatives before entering into an agreement with a debt relief program provider.

Megan Doyle

Megan Doyle is a business technology writer and researcher whose work focuses on financial services and cross-cultural diversity and inclusion.

 

All Credit Intel content is written by freelance authors and commissioned and paid for by American Express. 

The material made available for you on this website, Credit Intel, is for informational purposes only and is not intended to provide legal, tax or financial advice. If you have questions, please consult your own professional legal, tax and financial advisors.