Debt Settlement: Is The Cure Worse Than The Disease?

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Everyone knows the story.  Unemployment is up. FICO scores are down.  Home values are down.  And because home values are down, home equity has disappeared for millions of homeowners.  And since home equity was the financial safety net millions of consumers used to pay off their credit card debt, well, you know the rest.  Let’s just agree that, right now, millions of consumers have no way to pay off all of their credit card debt.

There are a variety of ways to get out of credit card debt, right?  You can budget your way out of debt.  You can file bankruptcy.  You can enroll in a debt management plan (DMP) through one of the member organizations of the National Foundation for Credit Counseling, commonly referred to as Consumer Credit Counseling Service (CCCS).  You can work with your credit card issuer directly and seek help through one of their hardship programs.  You can attempt to settle the debt on your own.  Or you can enlist the services of a debt settlement company.

Opinions vary on these options.  They all have their pros and cons.  The purpose of my article isn’t to explore each option.  I’ll do that soon.

The purpose of this article is to explore debt settlement as an option.

Settlement is quite an easy concept to understand.  You agree to pay your credit card issuer an amount of money less than what you really own them and they consider the debt to be paid in full.  So, if you owe John Ulzheimer’s Bank $10,000 and I agree to accept $5,000 as “full payment” then you have settled your debt with John Ulzheimer’s Bank.  The bank reports the settlement to the credit reporting agencies and sends you a 1099 for the forgiven amount.  Settlement, incidentally, is considered one of FICO’s Seven Deadly Sins.

Settlement can be accomplished by working directly with your bank.  You do not have to hire someone to do this for you.  That’s a myth. In fact, many credit card issuers won’t even work with debt settlement companies so you have no choice but to deal with them directly.  This is okay because all creditors have their version of a “Remediation” department, which is where you’ll likely end up if you call them asking for a settlement deal.

Now, let’s move on to the debt settlement companies.  You’ve all seen their commercials.  Distraught couples staring at their credit card statements magically turning into happy families playing with puppies in their front yard, all thanks to ye ole friendly debt settlement company.  Heck, there’s even a version that has excerpts from one of President Obama’s speeches and a picture of a government building in the background.  It’s clearly intended to come across as a governmental program.  Of course, it’s not a government program.

Here’s how they work.  First they find out how much debt you have.  This is to determine if you’re even worth doing business with.  If you have too little debt then they won’t make enough money working with you.  That’s why their ads contain statements like “If you have more than $10,000 in credit card debt call now…” If you have enough debt, in their eyes, then they’ll sign you up.

When you sign up they’ll tell you to stop communicating with your credit card issuers.  I’m not kidding, they really tell you this.  That means no more payments and no more return calls.  The hypothesis here is to get your credit card issuer so desperate for payment that they’ll accept a settlement offer.

At the same time you’ll be asked to make monthly payments to the settlement company.  Why?  Because you’re creating a war chest that serves two purposes.  First, this is where their fees will come from.  Second, this is where the settlement offer will come from.

After several months, or longer, there will be enough money for them to make some sort of offer to the credit card issuer.  The issuer may accept the offer, or they may decline the offer.  Either way, your fees to the settlement company have been paid.

So what happens during the period of time you’re paying the debt settlement company (and ignoring your creditors)?  Well, since that’s not a part of the commercials I’ll have to be the one who breaks the bad news.

1. Your credit will be trashed.

The credit card issuer will report the ascending level of late payments to the credit bureaus, which remain on your credit file for seven years.  Now the debt settlement guys will say “well, your credit is probably already trashed so no big deal.”  Wrong, new (and numerous) late payments help to lock in lower scores for additional time.  And it gets worse…

2. The card issuer will likely enlist the services of a 3rd party collection agency to collect the debt.

This means a brand new collection will be reported to your credit files. Again, this remains for seven years.  And, these guys can pull your credit reports to find you and determine your ability to pay them.  That means you’ll have to explain collection inquiries.  You’re supposed to ignore these guys as well.  And it gets worse…

3. That knock at your door…yeah, that guy is called a process server. 

Your credit card company or a collection attorney has sued you for nonpayment of the debt.  You can’t ignore him like you’ve been ignoring your credit card issuer.  If you do choose to ignore the summons you’ll lose by default for not showing up to court.  This is called a default judgment.  And yes, the judgment can show up on your credit report for seven years.  And it gets worse…

4. Become familiar with the term “Writ of Sequestration.”

In English this is either legal garnishment of your wages or seizure of your assets.  If your wages are garnished your employer will now be made aware of your defaulted debt problems because they’re the ones who will hold back a portion of your salary.

You’ve totally lost control of the situation because you chose to ignore your creditors, at the request of a company trying to profit off of your debt situation.  Smart?  Or not?

And, just to tie a nice bow on the top of this one, the Attorneys General in the states of Florida and Alabama have shut down major debt settlement networks because, and I quote, “they’re a scam because consumers get no value for their fees.”  I’ll write soon about the DSCPA (Debt Settlement Consumer Protection Act), which will put most of these guys out of business.

John Ulzheimer is the President of Consumer Education at, the credit blogger for, and the author of the “credit history” definition on Wikipedia.  He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and, John is the only recognized credit expert who actually comes from the credit industry.  He has served as a credit expert witness in more than 70 cases and has been qualified to testify in both Federal and State court on the topic of consumer credit.

Save more, spend smarter, and make your money go further