debtHave you ever heard the phrase, “When it gets dark outside the rats come out to play?” That phrase is certainly true in the world of consumer debt. Consumers who find themselves in excessive debt and the possibility of facing a debt settlement company have quite a few options when dealing with their debt problems. Some are good and some that could best be described as the “rats.”

One such option is to hire and work with a professional debt settlement company. Hiring a settlement company certainly comes with pros and cons, many of which the debtor is unaware. Here’s how it all works:

Services provided by debt settlement company

Debt settlement companies offer the service of working with your creditors to negotiate settlements.

A settlement occurs when one of your creditors accepts less than what you actually owe them and calls it even. And while this may sound like a great option, settlements can be problematic.

First off, debt settlement companies do not provide any services that consumers cannot perform on their own. The act of calling a credit card issuer, offering to settle the debt for less than the amount owed, and negotiating back and forth until a final settlement is agreed upon can be executed by any consumer.

That’s not necessarily a “con,” but consumers shouldn’t be under the assumption that debt settlement companies are their only choice when working with their creditors.

To be fair, the fact that a debt settlement company provides a service that people can complete on their own can also be said of a variety of other service providers including barbers, tax preparers, house painters, and a host of other professionals. The unknown is whether the consumer can perform the service as effectively as a debt settlement company.

How the process works

When a consumer signs up with a debt settlement company he will be instructed to stop making payments to his credit card issuer. The instructions will not only be to stop making payments but to also stop all forms of communication with the credit card issuer.

During the period that the consumer has halted payments to his credit card issuer he will begin making monthly payments directly to the debt settlement company. Those monthly payments will have fees subtracted by the debt settlement company and the remainder will be stockpiled for negotiating with the credit card issuer some time down the road.

Once enough funds have been stockpiled, the debt settlement company will contact the consumer’s card issuer and attempt to settle the debt for less than the amount owed. Whether the card company accepts the offer or not, remember that the debt settlement company has already been paid from the fees it has taken out of the consumer’s negotiations stockpile.

Credit score implications

Any smart consumer is going to realize what will happen to their credit scores when they stop making payments to creditors.

Even if a consumer was already having credit problems the additional late payments will compound the credit score damage. It will also prolong the score damage for a longer period because of how long settlements can remain on credit reports.

What you’re not told

If your credit card issuer agrees to a settlement they are going to forgive some amount of debt. When they forgive debt that creates what’s referred to as a “taxable event.” Some time after your settlement is complete the credit card issuer will send you tax form 1099C, or a “cancellation of debt.” You will be liable for taxes on the forgiven amount of debt, which could represent a considerable tax obligation especially if the card issuer forgave a large amount.

There’s also a decent chance that your credit card issuer will sue you while you’re not paying them. Credit card issuers don’t care that you’ve hired a debt settlement company but they do care that you’ve stopped making payments.

Depending on the issuer, they could file a lawsuit against you for the defaulted debt and that poses a number of other problems like attorney’s fees, default judgments and even potential wage garnishments.

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