For some, moving ahead with a debt relief company is an unavoidable last resort if bankruptcy is looming. Before moving ahead with this choice it is important to understand the risks that accompany it and how to lessen any future issues.

What is the process of working with a debt relief company?
A debt relief company will work with creditors to manage the build-up of your delinquent debt.

Debt settlement risks

While the risk of complete financial bankruptcy is real, it is important to understand other negative outcomes that come with the choice to undergo the process of debt relief.

Steep fees

You should prepare to spend some extra money during the debt settlement process. These tend to include balance transfer fees, closing costs and origination fees. It is typical for settlement companies to charge up to 25 percent of your debt in fees and additional costs.

Hit to credit score

During the process of debt settlement, you are required to stop making payments to creditors which negatively impacts your score. On top of this, any settled debts will stay on your report for up to seven years, making it challenging for you to borrow money in the future.

Lack of negotiation

While the role of the company is to handle negotiation of your debt, you will not have the ability to decide the amount that you pay for this negotiation to occur. This downside means you could end up spending an excessive amount of money, outside of your control.

Possibly high taxes

Any amount of money that is settled in the process is then seen in the eyes of the IRS as taxable income. This means that, in some cases, you will owe taxes on that amount of money in the same way you have to pay taxes on earned income.

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Keep in mind: If you have settled more than $600 worth of debt, your lender will give you a 1099-C to fill out.

Potential legal issues

Although running into legal issues is a possibility when it comes to any financial endeavor, the risk that comes with working with a debt settlement company is slightly higher. The job of the debt settlement company means that your best interest is not always top of mind, which makes possible legal trouble more common.

Alternatives to debt settlement

Before moving forward with a debt settlement company as the last ditch effort, consider some alternatives that could help you settle your debt, better your finances and avoid potential risks.

  • Budget. When reassessing the state of your spending, look out for any areas you could save money and, in turn, pay down previous debt. One way to do this is through the 50/30/20 rule, separating your spending into needs, wants and savings.
  • Be proactive. Before your debt builds to an unattainable number, it is important to connect with your creditors and explain the situation you are in. While this may feel scary, it is important not to put off the inevitable and instead get a handle on your debt as soon as possible.
  • Connect with a professional. Outside of reaching out to your creditors, it can be helpful to speak with an advisor or rep from the bank. These individuals are specifically trained and can provide advice and guidance through the process.

Look out for debt relief scams

Unfortunately, scammers prey on folks that are in a precarious situation as they know that many seeking debt relief are desperate for help. Come equipped with the knowledge that these scams are common but easy to avoid. Look out for these red flags.

  • Perfect solution. If a company promises all of your debt to disappear in one fell swoop, it is likely too good to be true. Another common ploy here is the promise to pay it off for pennies on the dollar.
  • New government program. If a new government program has been rolled out to relieve your debt, you would get direct notification on it. Do not trust a representative that tells this story.
  • Cut off communication. Sometimes scammers will advise you to cease any communication with your lender or creditor. This will likely create more financial issues in the future and is a reason for pause.

Bottom line

Looming bankruptcy is scary, and the choice to work with a debt settlement company is the right move for some. But before doing so it is important to remember the risks that come with it. Prepare for: steep fees, a hit to your credit score, lack of negotiation, possible high taxes and potential legal issues.

Finally, when looking for a debt settlement company, look out for common scams. If a representative sounds too good to be true, it probably is.