Consumers who find themselves struggling with debt are often on the lookout for an easy fix. Unfortunately, there are some debt relief options that prey on this desperation by making misleading promises to consumers. The best first step is to try credit counseling through a nonprofit agency rather than jumping into a settlement or resolution program. A free counseling session can clarify the consequences of different debt assistance options.
Key Differences Between Debt Settlement Companies and Credit Counseling Agencies
The common claim you’ll hear in debt settlement commercials is that they can eliminate debt for “less than what you owe.” While this can be true, it is not without serious long-term consequences. Here’s how the process works:
- First, a settlement representative will instruct you to stop paying your creditors. Instead, you’ll make monthly payments directly to the debt settlement company, which they will put in an escrow account.
- As a result, your debts will go into default status if they were not already. It is also possible that the debt will be turned over to a collection agency.
- After you’ve made enough payments to build up a large enough lump sum, usually around 36 months, the settlement company will contact your creditor or collection agency to negotiate a settlement amount.
- Finally, they will pay the creditor using the funds accrued through your payments.
The problem with this process is that it destroys your credit. Not only do your debts go into default, but you will also get a notation on your credit report stating that you settled the debt without paying back the full amount. Additionally, the difference between the amount you owed and what you settled for will be taxed as income. This could leave you with an unreasonably high tax bill that is difficult to pay off.
How is Credit Counseling Different?
Credit counseling, specifically through a nonprofit agency, is primarily a review of current financial standing. During a session, counselors access your credit report, help design an effective budget, and identify the most appropriate debt solutions for your specific situation.
The last part is critical for anyone considering extreme options like debt settlement or bankruptcy. Credit counselors don’t tell you what method of debt resolution to use. Instead, they go over a number of options and discuss the benefits and consequences of each strategy.
If you are a good candidate, they may offer to enroll you in a debt management or loan consolidation program. In most cases, these options are better than debt settlement because they help you repay debts faster without damaging credit.