Key takeaways

  • Debt settlement firms legally cannot charge the consumer any upfront fees and can only charge fees based on the settled debt amounts.
  • There are a plethora of potential scammers fronting as debt relief or settlement companies so know your consumer rights before applying.
  • Working with a firm won't guarantee that your debts will be settled and is often a costly process.

If you’ve ever had a hard time paying off your credit card debt for an extended period of time, it’s likely a debt settlement firm has reached out to you.

Debt settlement firms exist as the middle-man between the consumer and the creditor in an attempt to settle — or discharge — most or all of the delinquent debt. While this may seem effective, there are downsides to be aware of, including the high fees that accompany these services and potential scammers who will attempt to charge upfront fees.

What can a debt settlement firm do for you?

Debt settlement firms are businesses that will negotiate with your creditor to “settle” your debt for you. Typically, they’ll claim that they can help you cut down your debt to pennies for each dollar you owe.

On your end, you will likely have to set aside a monthly amount in an escrow account until enough money accumulates for the debt settlement firm to pay off your creditor.  Most will tell you to stop making payments to your card issuers or to cease communicating with them directly as they negotiate the debts with your creditors.

Debt settlement firms legally can’t charge upfront fees

One warning sign to watch for is if a debt settlement firm asks you to pay an upfront fee. The Telemarketing Sales Rule, which goes back to 1995, monitors calls that these firms make to prospective customers, either on their own or through a third party, as well as inbound calls from prospective customers.

The rule also specifically forbids these firms from collecting upfront fees before they have successfully settled any of the debt on your behalf. A legitimate company will walk you through the process step-by-step, as you’ll need to sign-off on your settled or forgiven debt. That being said, any fees charged to you should never come as a surprise and should be outlined well in advance.

When to expect a fee from a debt settlement firm

Legitimate companies will have you agree to the terms of any settlement they reach with your creditors. Although the agreement with the creditor should be in writing, you could agree to the terms orally, but make sure you have a paper-trail backing up the agreement details.

You should have made at least one payment to the creditor, or debt collector, based on the settlement agreement that the firm made on your behalf. That being said, if you have credit card debts with multiple issuers and the debt settlement service settles one of them for you, it can only charge a fee proportional to the debt settled.

For instance, if you owe three different issuers $2,000 each, and the debt settlement firm’s fee is a total of $1,000, it can only charge you $333.30 after it has settled your debt with one of the issuers, or a third of the total fee for settling a third of your debt.

Debt settlement firms should also disclose to you upfront how long it will take them to successfully negotiate, around how much it could cost you, any potential negative ramifications on your finances and information and your responsibility as the debt-holder.

How debt settlement fees work

The firm’s website should clearly lay out its fee structure. For example, most settlement companies charge a fixed fee between 15 percent to 27 percent of the total amount of enrolled debt.

Once you sign the contract and agree to the exact fee structure, then you should be charged the same percentage amount for each debt it settles, regardless of the balance type or amount.

For instance, if the firm charges you 30 percent of the settled debt and negotiates your payment down to $1500 with one of the issuers, it can charge you 30 percent of the $500 it saved you, or $150. And it should charge you the same base percentage for each debt it settles after that.

Keep in mind that these firms don’t have the legal jurisdiction to get you to sign agreements concerning future or potential settlements. If a representative is trying to get you to sign on a future agreement, contact the Federal Trade Commission (FTC) to report the company for suspicious or unlawful practices.

What to look out for when settling your debt with a firm

In a bid to get around the FTC’s ban on upfront fees, it seems that debt settlement firms have resorted to workarounds. For example, the company  might affiliate themselves with attorneys (who aren’t legally beholden to the upfront fee rule) in an attempt to collect more money from you.

The companies will often market themselves to consumers as an attorney service. However, do your due-diligence and read the fine print to make sure it’s not a front for a debt settlement firm.

Another common tactic that’s been used by settlement companies includes luring prospective customers into a face-to-face meeting, rather than a phone call. This is done so that the conversation isn’t covered by the Telemarketing Sales Rule and it becomes easier for the company to charge illegal fees or engage in misleading or illicit practices.

The bottom line

If you are contemplating using the services of a debt settlement firm, know your full portfolio of consumer rights, including what fees you can and can’t be charged. If a settlement firm doesn’t seem like the best or safest option for you, you may be able to negotiate with your creditor yourself, or go through an accredited, non-profit credit counseling firm that could help you set up a debt management plan.

If you qualify for lower interest rates or a more favorable repayment term, you could also consolidate all your debt into a lower interest rate loan and slowly pay it off. Another option is to sign up for a balance transfer credit card, depending on how much you owe and whether you can qualify for a competitive rate.

Regardless of the option you choose, make sure you’re diligent about repaying your debt, both now and in the future should any amount be settled, to avoid further debt accrual and damage to your credit score.