Is Your Debt Relief Company Legit?

Debt is a big deal for millions of us, and a debt relief company promises real help for a real problem. As living costs escalate, it's easier to get into debt and harder to climb out, so a lot of Americans seek help with their debt, and some turn to a debt relief company for it. 

You may have heard that debt relief companies can help you settle certain debts for less than you owe. It might sound too good to be true. It’s not, but it’s also not a get-out-of-debt-free card.

A legitimate debt relief company charges no fees until it settles a debt, keeps your funds in an account you control, and answers your questions clearly and directly. Unsolicited calls promising to erase your debt, requests for payment before any settlement happens, and vague answers to direct questions are the clearest signs of a scam.

What Is Debt Relief?

Debt relief is a broad term for any strategy that eases the burden of overwhelming debt, including a consolidation loan, a debt management plan, bankruptcy, or debt settlement. One specific type of debt relief is debt settlement, also called debt negotiation. 

A debt settlement company works directly with your creditors to settle your unsecured debts for less than the full balance you owe. Debt settlement typically works best for credit card balances, medical bills, personal loans, and other unsecured debts. Most programs require that you have significant debt. Freedom Debt Relief’s program is designed for people with at least $7,500 in unsecured debt. The entire program can be completed in as little as two to four years.

Debt settlement may negatively impact your credit.

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Signs Your Debt Relief Company Is Legit

Most companies in this industry operate honestly. Some don't, so learn the difference before you commit to a program. 

In 2010, the Federal Trade Commission introduced new rules to protect consumers after some companies in the debt settlement industry failed to act in their clients' best interests. Industry groups such as the Association for Consumer Debt Relief formed around the same time to establish standards for transparency and consumer protection. Research a company thoroughly before you hire it, and expect a legitimate provider to answer your questions openly.

Red flags of a scam

• Contacts you first. Legitimate debt relief companies don't cold-call or send unsolicited texts promising to erase your debt. Be cautious of unexpected outreach, especially if it mentions a new government debt program.

• Charges fees before settling a debt. Debt settlement companies can’t charge fees for debt settlement until they negotiate a settlement on your behalf, you accept it, and at least one payment is made toward it.

• Promises to settle every debt for one flat reduction. Each creditor and each debt is different, so settlements vary case by case.

• Touts a special government program. No government program exists to erase credit card debt.

• Guarantees a specific result. No company can promise it will settle your debt for a set amount, because your creditors decide whether to accept an offer.

• Claims it can stop every collection call or lawsuit. A debt relief company doesn't have that power. Once you stop paying a creditor to save for a settlement, collection calls are likely and lawsuits are possible.

• Tells you to cut off all contact with creditors. That decision belongs to you. A trustworthy company explains your options instead of making that call for you.

• Gives vague or evasive answers. A reputable company answers questions about fees, timelines, and the settlement process directly.

• Has a poor Better Business Bureau rating. A high volume of unresolved complaints on file is worth taking seriously.

• Asks for access to your bank or credit card accounts. Never share login or password information with anyone, including a debt relief company.

Signs of a legitimate company

A dedicated account is a normal part of the debt settlement process. Your debt settlement company will help open this account at an FDIC-insured bank or NCUA-insured credit union. This is where you’ll make deposits each month to build funds for settlement offers. Your money stays yours the entire time. You always own and control the account. 

A licensed debt relief company registers with the states where it operates. You can confirm a company's license and check for complaints through your state attorney general's office or state financial regulator before you sign up.

Accreditation from an independent industry group is another positive sign. Organizations like the Association for Consumer Debt Relief hold member companies to standards for transparency and ethical practices. For example, Freedom Debt Relief facts are published for anyone to review, including its licensing and accreditations.

How Debt Settlement Works

The process starts with a consultation. A debt relief company reviews your finances and explains your options. If you enroll, you’ll make an affordable monthly deposit into your dedicated account to save up money toward settlement offers. 

Negotiators then work with your creditors to reach settlement agreements. You review and approve every agreement before any money moves. Once you approve an agreement, payment is made from your dedicated account. The debt settlement company’s fee is paid from the same account. 

Most clients get their first debt settled within a few months of enrolling. Completing an entire program is possible in as little as two to four years.

What Does Debt Settlement Cost?

Fees vary by company. Debt relief companies generally charge 15% to 25% of the debt you enroll for settlement. 

For example, say you have $30,000 in debt and the company's fee is 25%, or $7,500. If a negotiator settles that debt for $12,000, your total cost is $19,500: the $12,000 settlement plus the $7,500 fee.

No debt relief company can guarantee a specific amount of savings. Your creditors decide whether to accept a settlement offer, and the outcome depends on factors like the amount and status of the debt, the creditor, your financial situation, and how negotiations go.

Your dedicated account sits at an FDIC-insured bank or NCUA-insured credit union, and that institution may charge its own setup or monthly maintenance fee for the account. A debt relief company doesn't set or collect that fee.

Tax Implications of Debt Settlement

Settled debt can carry tax consequences. The IRS generally treats forgiven debt as taxable income, so if a creditor forgives $1,000 of your debt, that amount is treated the same as if someone paid you $1,000. 

When a creditor settles your debt for less than you owe, it issues a Form 1099-C that reports the forgiven amount to the IRS. You report that amount on your tax return for the year the debt is settled. If your total debts exceed the value of what you own at the time of settlement, you’re insolvent. When you’re insolvent, the IRS doesn't require you to pay federal income tax on the forgiven amount. 

For more detail, review the tax consequences of debt settlement.

Pros and Cons of Debt Settlement

Pros:

• Debt reduction. A settlement could reduce what you owe by a meaningful amount, depending on your creditors and your negotiator's results.

• One monthly deposit. Instead of juggling several bills, you make one affordable deposit into your dedicated account each month.

• Professional negotiation. It’s what they do best. The debt relief company will negotiate with your creditors regularly and may reach a better outcome than you could achieve alone.

• A faster path than minimum payments. Debt settlement could get rid of your debt sooner than minimum payments alone.

Cons:

• Credit score impact. Missed payments while you save for a settlement, plus the settled accounts themselves, could lower your credit score and stay on your credit report for years.

• Possible tax consequences. The portion of your debt a creditor forgives could count as taxable income.

• Fees. A debt relief company charges a percentage of your enrolled debt once it settles.

• No guaranteed outcome. Your creditors decide whether to accept a settlement offer, so results vary by creditor and situation.

Alternatives to Debt Settlement

Debt settlement is one path among several, each with its own costs and trade-offs.

Repay your debt yourself

Review your income and debts to check whether you could repay everything yourself, using a strategy like the debt snowball or debt avalanche. The only cost is the debt itself.

Debt consolidation loans

A debt consolidation loan combines multiple debts into one new loan. If you're approved, the loan is used to pay your creditors directly, and you make a single monthly payment on the new loan going forward. A debt consolidation loan doesn't reduce the amount of debt you owe. A loan with a lower interest rate could make your debt more manageable. Because no debt is forgiven, there's no tax bill. The cost depends on your new loan's interest rate and any origination fees your lender charges.

Negotiate your own settlement

You can contact your creditors directly and negotiate a settlement without hiring a company. It takes persistence: creditors want to be repaid, so an early offer is unlikely to be generous. With enough persistence, you could reach a settlement on your own. Your cost is the negotiated amount for each debt.

Debt management plans

A debt management plan (DMP) is a repayment plan run by a credit counseling agency. The goal isn't to reduce what you owe. Instead, you repay your full debt with support and guidance from the credit counselor. A DMP can be harder to stick with than a settlement plan because you don't get a reduction on the total balance, and payments are designed to clear your debt in three to five years. Because you repay your debt in full, a DMP carries no tax bill. The cost is your full debt plus a modest monthly fee, typically under $50.

Chapter 7 bankruptcy

In a Chapter 7 bankruptcy, a court may sell some of your property and use the proceeds to pay your creditors. The court then discharges (forgives) your remaining qualified debts. Not everyone qualifies: if you can afford a monthly payment, you generally don't qualify for Chapter 7. The court will compare your income and household size to the median income in your area. Chapter 7 cases typically finish within a few months, and debt forgiven through bankruptcy isn't taxable. The cost depends on the type of bankruptcy, how complex your case is, court fees, and whether you hire an attorney.