What are debt relief companies and how do they work?

If you’re struggling to pay off your debt and at risk of defaulting, a debt relief company may be able to provide assistance. Debt relief can come in a few forms, including self-driven ones, but a debt relief company can help you navigate whichever process is best for your situation — typically at a cost.

What are debt relief companies?

Debt relief companies are for-profit institutions that help you manage and pay down your debts. Depending on the company and what services are offered, they may work with creditors to help you get out of debt for less than what you originally owed.

Most debt relief companies charge a hefty fee for their services. However, like lenders and credit card issuers, each company offers different services. Debt consolidation, debt settlement, credit counseling and debt management are the most common options.

How do debt relief companies work?

Debt relief companies exist to help consumers lower their debt or better manage their repayments — for a fee. These fees should never be requested upfront and should only be charged once your debts have been settled or resolved. More than that, if any business guarantees it can settle your debt, take your business elsewhere. This is a sign that the organization may be a debt relief scam.

Most relief companies require an initial consultation to determine eligibility and to decide which method is best for you. However, it’s important to walk into the process prepared by knowing all your options.

Types of debt relief

No single debt relief method will work under every circumstance. Thankfully, most companies offer a few options to suit a range of needs.

Debt settlement

Best for those who have exhausted all other relief options.

Debt settlement companies work with your creditors on your behalf to negotiate your total debt amount with the aim of reducing your repayment responsibility. These services aren’t free. You’ll be charged a fee — typically between 15 to 25 percent of your total debts enrolled — after your debts are settled.

As a customer, you won’t be responsible for communicating with your creditors if the debts are settled. But you will have to make monthly payments, likely to a savings account you control, and those funds will then be sent to your creditors.

Potential risks of debt settlement include

• Settlement requires you to stop making your payments to creditors, which will negatively affect your credit score.
• Settled debts remain on your credit report for up to seven years and are marked as “partially paid,” which impacts your ability to borrow in the future.
• Your creditors are under no legal obligation to work with a settlement company and may refuse, leaving you with additional fees and interest to pay.

Debt consolidation

Best for borrowers with a steady income and good credit score (or co-signer).

Debt consolidation is the process of merging multiple accounts into one to streamline and simplify repayment, save on interest and possibly land better terms than what you have now. While you can complete this process independently, you can also work with a third-party debt relief company if you prefer having assistance.

You can consolidate multiple balances from loans and credit cards using a debt consolidation loan, which will come with one fixed monthly payment. You can also consolidate multiple credit accounts into one with a balance transfer credit card. Regardless of your debt type, this method won’t benefit your finances if you’re offered a higher interest rate than what you currently pay.

Potential risks of debt consolidation

• Potential upfront fees like balance transfer fees, closing costs and origination fees.
• Unless you have a good or excellent credit score, you may not get approved or be offered a lower interest rate.
• If you miss any payments, you’ll incur more credit damage that will likely result in heavy fees, like late payment fees or an insufficient funds fee.

Debt management

Best for those who need a structured repayment plan.

A debt management plan (DMP) is a repayment plan for people with multiple debt balances. You’ll work with a debt relief company or credit counselor to pay down your existing debt in three to five years.

When pursuing debt management, the company or counselor you’re working with will contact your creditors directly to negotiate your loan terms and balance. You’ll make monthly payments to an account you control that will be distributed to your creditors.

Before choosing this relief method, make sure your overall monthly payment is less on the DMP than it is normally.

Potential risks of debt management

• Some of your creditors may not agree to work with the company.
• You may be asked to close all active lines of credit, which will affect your credit score.
• Your creditor could mark a DMP on your credit report if it accepts the plan.

Credit counseling

Best for those who prefer personalized guidance.

Credit counseling is commonly offered by nonprofit organizations and agencies. It can be free and comes with no strings attached.

When you start working with a counseling agency, you’ll have a one-on-one consultation with a specialist who will take a look at your finances and come up with a debt relief plan with you. A counselor may suggest working with a relief company to settle or negotiate your debts, enrolling in a debt management plan (DMP) or may help you come up with a plan to manage your debts on your own based on your income.

Potential risks of credit counseling

• This option may come at a cost, although specific fees will vary depending on the organization you work with.
• The amount of money that you owe will not change and you will be expected to pay down all that you owe.

What to look for in a debt relief company

Certification, fees and repayment time are the three main factors to prioritize when comparing debt relief companies.

1. Certification: Any debt relief company should be backed by the National Foundation for Credit Counseling and the Financial Counseling Association of America. If the company lacks these certifications, you’ll want to take your business elsewhere.
2. Fees charged: Most debt relief companies will charge a fee between 15 percent and 25 percent of the total debt enrolled for settlement. Companies may also charge fees for opening and managing the savings account required to make payments.
3. Repayment timeline: It typically takes between two to four years to complete a debt settlement program. However, this is based on the total amount of debt and creditors you have. Check the website to make sure the predicted timeline matches your needs.

Frequently asked questions

• Do debt relief companies charge fees?

  Yes. Debt relief companies charge fees in exchange for their services. The amount you’re charged depends on the company you work with and the relief method you choose. Keep in mind that legitimate companies should never ask you to pay fees upfront — if you’re asked to provide this, it’s likely a scam.

• How long will debt relief affect your credit score?

  Working with a relief company will typically result in an immediate negative impact on your credit score. The degree to which your score drops depends on the relief method you choose and whether your creditors decide to report it.

• Is debt relief good or bad?

  In most situations, debt relief isn’t something that will be immediately good for your finances. For one, it’s often a costly undertaking due to the fees charged by the companies. It also has detrimental impacts to your credit score, lasting for a minimum of seven years on your report.
  
  
  But in some situations, it may be the only way to avoid bankruptcy. When considering whether to pursue debt settlement also look into credit counseling from a nonprofit agency.

• How do I qualify for debt relief?

  Consumers who have a qualifying type and amount of delinquent debt generally can qualify for debt relief. However, each company has different approval and minimum debt criteria.