Chances are, you have seen one of the ubiquitous commercials for debt relief companies claiming they can reduce the amount you owe by half and get you out of debt in an enticingly short period of time.
You may also have once placed a tooth under your pillow and awakened to find a shiny new quarter.
While there are some legitimate debt relief companies that comply with federal law (and lots of fraudulent ones), their services are extremely costly, damage your credit score and leave many people who engage them worse off than they began.
In fact, a 2021 Harvard Kennedy School report found that fewer than one in four creditors who engaged a debt relief company successfully settled all of their accounts after three years. This option should be relegated to a last resort short of filing for bankruptcy, and perhaps not even then.
Generally strong consumer spending is holding up the U.S. economy and driving earnings and stock prices higher. But for a significant portion of households, debt is becoming an increasing burden.
According to the New York Fed, household debt reached a record $17.8 trillion in the second quarter of 2024. Credit card balances also reached a new high of $1.14 trillion, with an average of $6,329 per creditor for the 50% of adults who carry a balance. Meanwhile, delinquencies are on the rise and accelerating. No wonder the promises of vanquishing debt with a simple phone call are so appealing.
For Americans carrying the weight of heavy debt, it is important to know there are options but also to realize that there is no magic bullet. All routes to financial stability require effort, sacrifice and time, but making the wrong choice can extend the pain. Understanding how debt relief services operate may help you make a better choice.
First it is helpful to know that not all debt is eligible for forgiveness. Generally, only unsecured obligations like medical bills, credit cards and personal loans are subject to negotiation. Secured obligations like your mortgage or car loan are not on the table. Student loans are also generally not in play.
Once you sign a contract with a debt relief company, you make monthly payments into a separate bank account held in trust. You will also be told to stop making any payments directly to the creditors involved. Once the company believes it has amassed a sufficient balance in your account, it will approach your creditors with an offer to settle for less than you owe. There are some real problems here.
For one thing, your credit record will take a pounding, both because of the substantial delinquencies you accrued and due to any charge offs they may agree to. Late fees and past due balances continue to swell. Secondly, any debt forgiven is generally considered income by the IRS. There is no guarantee that all the creditors will agree to a reduction, and in the meantime, you will continue to be subject to collection efforts and even legal action.
Then there are the fees. Expect to pay the debt settlement company 25% or more of the total amount of debt you enroll in the program. Even for the minority of customers who successfully complete the process, fees can eat up over half of the savings.
This industry is also notoriously rife with bad actors. Both the Federal Trade Commission and the Consumer Financial Protection Bureau have their hands full with enforcement actions targeting offenders who make false claims or charge up-front fees. The FTC maintains a list of hundreds of individuals and companies who have been banned from the industry. In 18 states, for-profit debt settlement has been banned altogether.
Households or individuals struggling with debt beyond their ability to comfortably service usually have better options than a for-profit debt settlement firm. The first step should be to contact an accredited, not-for-profit credit counseling agency for a free consultation to learn about better options for working out of the hole.
The National Foundation for Credit Counseling at NFCC.org can connect you with an associated agency in your area, like Consumer Credit Counseling Service in Chattanooga. A qualified counselor can help you evaluate your situation, carefully consider all your options and help you build a strategy to chip away at the debt.
A credit counseling agency may suggest a better route called a debt management program. As opposed to a debt settlement scheme, debt management offers a structured plan in which you make a single monthly payment to the agency, which then pays the creditors.
While they cannot decrease the principal amount you owe, they work with most lenders and credit card companies to adjust your interest rates and monthly payments, waive or reduce late fees, stop collector calls, and begin actually improving your credit score. The agency fees for a debt management program are typically just a fraction of a settlement agreement, and lenders look favorably on borrowers who pursue this path.
Millions of Americans have experienced the emotional and financial stress of excessive debt. The burden can feel overwhelming and lower resistance to enticing promises of relief that usually deliver less than promised and may even set you back further. Before you engage with a for-profit company, take the time to speak with an accredited, nonprofit counseling agency to fully understand all your options.
Christopher A. Hopkins, CFA, is a co-founder of Apogee Wealth Partners in Chattanooga.
Christopher A. Hopkins