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Few situations in life are more stressful than being buried under a pile of debt. Unfortunately, high debt is a way of life for many. As of April 2018, the average credit card debt for indebted households in the United States was more than $9,300.
Debt problems are not only stressful, but they can also be incredibly expensive. To make matters worse, maxing out your credit cards may also damage your credit score, even if you’re on time with your payments.
If you’re searching for ways to deal with your debt, consolidation is an approach worth considering. However, the term “debt consolidation” gets used for several types of services, including debt management and debt settlement (aka debt relief). Scammers, unfortunately, take advantage of people desperate to get out of debt and make bogus promises they can’t keep.
Here’s some background on debt consolidation and how to stay away from scams.
What is debt consolidation?
Debt consolidation is a DIY process in which you pay off high-interest debts — usually credit card balances — with a new debt consolidation loan or a balance transfer credit card that has a lower interest rate. You’ll end up with one monthly bill instead of many, and hopefully, an interest rate that saves you money in the long run, even after taking into account any fees associated with the consolidation loan or balance transfer card.
The hard part about debt consolidation is that it typically works best for people who have good credit scores and are not struggling to make their monthly payments. If you don’t have a good score, you may not be approved. Or you may only be able to get a loan or balance transfer card with terms so poor that you won’t save any money by consolidating.
That’s where these alternatives come in:
Debt management plan (DMP): Your credit score won’t matter for a debt management plan. A DMP is administered by a nonprofit credit counseling agency as a way for you to pay down your debts on a timeline that works for you and for your creditors. The agency tries to negotiate lower interest rates on your behalf.
With a DMP, you give your money to the counseling agency each month. The agency uses those funds, minus fees, to pay your bills. You’re usually required to close your credit cards during this time, which could hurt your credit score. The DMP is noted on your credit report, and lenders usually won’t extend you any new credit until you complete the plan.
Debt settlement: Debt settlement companies, also known as debt relief companies, sometimes advertise their services as “debt consolidation.” Yet in reality, they’re very different.
The goal of debt settlement is not just to get you a lower interest rate, but to get creditors to agree to take less money than what they’re owed. To do this, debt settlement companies typically require you to stop paying your creditors for months until the creditors cry uncle and agree to settle.
The idea of paying less to your creditors may sound appealing on the surface. But you’ll suffer severe credit damage and you may be sued by your creditors. And while not all debt settlement companies are bad actors, it’s an industry filled with scammers.
How to spot a debt consolidation scam
First of all, any company offering to guide you through debt consolidation is probably steering you wrong. As mentioned above, debt consolidation is something you do on your own.
If an outfit is calling itself a debt consolidation company, it may mean it’s a for-profit debt settlement firm. That doesn’t necessarily mean it’s a bad actor. But you should learn the red flags of a scam in advance.
Look for these three warning signs before signing up for any “debt consolidation” or debt settlement service:
1. The company pretends to have access to a ‘special government program’
If a debt relief company claims to have access to a new or special government program to help you reduce your debt, it’s a sure-fire sign that you’re probably dealing with a scam. In fact, both the Federal Trade Commission and the Consumer Financial Protection Bureau specifically warn consumers to avoid doing business with companies who make such claims.
2. The company charges upfront fees
Per the FTC, debt relief companies aren’t allowed to charge you a fee before your debt has been settled or reduced. If a company tries to pressure you into paying fees upfront, that’s a red flag.
It’s worth noting that it’s not illegal for a debt settlement company to ask you to deposit funds into a dedicated account (separate from your own checking). That’s how it amasses the money it will use to eventually pay off your creditors. An unrelated third party may also charge a reasonable account maintenance fee.
3. The company guarantees to settle your debts for lower amounts.
Have you ever heard the saying that if something sounds too good to be true, it probably is? That statement applies to debt consolidation companies 100%. If a company makes too-big-to-believe promises or guarantees to settle your debt for pennies on the dollar, beware. Debt settlement companies try hard to reduce what you owe, but they can’t guarantee their success.
What to look for in a debt settlement company
For many people, DIY debt consolidation is best. However, some feel like they cannot pay off all of their debts and still keep a roof over their heads. In those cases, debt settlement may be a good fit. If you opt to go that route, do your homework to make sure you choose a reputable service provider.
Here are the most important things to look for in a debt settlement company:
- Cost and terms disclosure: A company representative takes the time to explain how you will be charged and the fees you should expect to pay for services. Terms and conditions of service should also be clearly disclosed upfront.
- No advance or extra fees: No one tries to charge you in advance or pressures you to make “voluntary contributions” — another term for fees.
- Risks explained clearly: The company explains the risks associated with its program — including the fact that many people quit the program before their debts are settled, your credit could be damaged and your creditors may keep calling and writing to collect your debts.
- You have access to your money: A reputable company will disclose that any funds you deposit into a dedicated account still belong to you, along with any interest your money earns. You should also be informed that you can withdraw your money at any time without any penalty charges.
The bottom line
Although there are plenty of bad apples in the industry, it would be wrong to say that everyone who works in the debt relief space is a scam artist. Still, it’s smart to consider all of your options before you make up your mind about the best way to handle your debt situation.
Do-it-yourself debt consolidation may work well if you’re looking to save on interest rates, but you have enough money to keep up with your monthly payments. However, if you’re struggling to make your minimum payments, you may need a more aggressive approach.
Taking the time to speak with a reputable, certified credit counselor for guidance may also be wise. Whether you decide to follow through with the counselor’s advice or not, at least you’ll be aware of some other options. You can find a credit counselor through the National Foundation for Credit Counselors and the Financial Counseling Association of America.
Above all, remember to breathe. Plenty of people have made their way through stressful debt situations before. With the right plan and some dedicated follow-through on your part, there’s no reason you can’t successfully fight your way through your own personal debt problems.