Can Debt Negotiation Ruin Your Credit?

(May 22nd, 2007)

Beware of any debt negotiation companies that promise to reduce your debts by "50%" by negotiating lower interest rates and lower monthly payments from creditors. This is because most of these debt negotiation companies will charge you enormously high fees and will ruin your credit just to get their job done. What's more, any settlement that you receive on your debts (any debt forgiveness) will also become taxable income for you!

Paul Richard, Director of the Institute of Consumer Financial Education based in San Diego quotes, "Be very, very careful because there can be substantially more harm than good. It's the fees, the possible liability to the IRS after you get this negotiated and they're not doing anything for you that you can't do yourself. These slick debt negotiators, they smooth talk people around all these issues. They're really taking advantage of people."

Let's explore a few of the pitfalls of dealing with debt negotiation companies shall we?

Enormous Fees Charged

Debt Negotiation companies will charge you enormous amounts of fees by using the following tactics:

-> Large upfront "down payment" type fee
-> Fee based on amount of debt you owe or # of creditors you owe to
-> Fee based on the amount of debt that a creditor is willing to wipe away

Daniel Benson, a senior Consumer Attorney at the Legal Aid Society of San Diego quotes, "There are all these hidden charges going on." For example, a debt negotiation company will say they will settle $6000 out of your $7500 credit card debt by negotiating with the lender. They will ask for a 25% - 35% fair share cut! This means you will have to pay them (25% x $6000 = $1500). You really aren't saving much are you? Plus, you will have to pay them additional administration fees as well as the initial upfront fee. You will actually be losing money in this case!

One of Benson's clients portrays a good example of the above. Benson's client was 82 years old and owed about $2200 of debt. The debt negotiation company charged her an initial $250 application fee, and after the debt was settled, charged her a $1350 in settlement fees. That's $1600 paid just in fees to settle a small debt of $2200!

Crush Your Credit Score

The first step a debt negotiation company will ask you to do is to stop making payments to your original creditors (lenders to whom you owe money). Instead, the debt negotiator will ask you to send him the payments! All these contributions you make to the debt negotiation company are stored in a separate account, until the negotiator is ready to make a settlement with the original creditor. This takes a long period of time, maybe even 4 - 6 months! And you know what happens if you do not make 6 months worth of payments to your credit card lender right? They will report you to the credit bureau and ruin your credit rating.

Dianne Wilkman, President of SpringBoard (a Nonprofit Consumer Credit Management Organization in Riverside, California) quotes, "They tell you to stop talking to creditors, which is a bad idea. Your creditor will charge off your account and that will ruin your credit." Creditors typically charge off a credit card account if there have no payments made on it for the past 6 months. A charge-off remains on your credit report for 7 years + 180 days from the first day of non-payment (Fair Credit Reporting Act). says "A charge-off is the biggest negative red flag on your credit report. It means a lender lost money doing business with you"

Even if a debt negotiation deal works out, your credit will be ruined. That's the good side of things. The bad side is that if the creditor refuses to accept the debt settlement deal, they have the right to sue you + your credit will be ruined!

Example of a Bad Debt Negotiation Company?

An example of a bad debt negotiation company recently in the news headlines is New Leaf Associates LLC, operating in New Port Richey, Florida. The company claimed it had a legal administrative procedure that helps its clients get rid of their credit card and student loan debt. After thousands of complaints received from the local Floridan community, the Attorney General of Florida filed a lawsuit against New Leaf Associates LLC on July 7th, 2006. It was determined that New Leaf LLC collected hefty amount of fees from 2200 clients and never terminated 1 single debt.

Instead of going through the risky procedure of debt negotiation, try some of the following alternatives.

-> Debt Consolidation

-> Do It Yourself Debt Reduction

-> Debt Elimination

-> Debt Settlement