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Debt Settlement, Credit Counseling, and Debt Consolidation...Exploring the Differences

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Jenny was in trouble with her credit card debt, and she resolved to get on the right track and avoid bankruptcy. She had heard about a debt settlement service and it sounded like a good idea: the company claimed it would negotiate with her creditors and arrange for Jenny to pay off her debts with one lump sum that was as much as fifty percent less than what she owed.

At the debt settlement company office, Jenny began to have suspicions. The "certified credit counselor" told Jenny that she would have to start making monthly payments into an escrow account, and the payments included not only her regular credit card payments but a set of substantial service fees owed to the debt settlement company. Only after 24, 36, or 48 months would the escrow account have enough funds to offer her creditors a lump sum settlement.

With horror Jenny realized that while she was paying the debt settlement company exorbitant fees every month, her creditors would be paid NOTHING. Interest charges and late fees would be piling up! The "certified credit counselor" assured her that this was perfectly fine and urged her to sign on the dotted line. Instead, Jenny got up and walked out.

Debt Settlement vs. Debt Consolidation

Jenny was lucky. Thousands of consumers have been bilked by debt settlement scams. What happens is that the creditors get no payments, so they start calling the debtor. They threaten collection and legal action. The hapless debtor contacts the debt settlement company, who suddenly does not return phone calls! Most debtors drop out of debt settlement programs and complain to the Better Business Bureau. In many cases they lose thousands of dollars and end up with more debt than when they started.

Another scam is credit card debt termination. This scheme is based on the bogus assertion that your debts are not "legal" and that the debt relief company can compel your creditor to wipe out your debt. Any company offering "debt termination" should be avoided.

Debt Consolidation can be a solution; it involves taking out one loan to pay off others. It can make sense if your credit is reasonably good. Here how it works: Say you have four or five credit cards, each with twenty percent interest rate and a total balance of ten thousand dollars. If you can get a $10,000 loan at an interest rate of ten percent, you can pay off all the cards, and you will save thousands in interest charges. In some cases you can do this yourself. Ways to get lower-interest cash include:

  • Take out a home equity loan
  • Do a "cash-out" refinancing
  • Refinance your car
  • Get a personal loan
  • Or, you an always try to negotiate better terms with your creditors

If this sounds daunting, credit counseling can be a good option. But where to start? Jenny contacted the National Foundation for Credit Counseling, which is the nation's largest and longest-serving national nonprofit credit counseling network. The NFCC has more than 100 member agencies and nearly 850 offices in communities throughout the country.

Jenny learned that credit counseling services run the gamut from legitimate to fraudulent. Many can provide effective low-cost advice and services; others will take your money and run. Here's what you should watch out for:

Lack of accreditation. Check to make sure the company is affiliated with the Association of Independent Consumer Credit Counseling Agencies or the National Foundation for Credit Counseling.

Big upfront fees. Legitimate consumer credit counseling services charge low upfront or setup fees-perhaps only ten dollars. Unless you're getting extensive professional financial advice, be wary of paying more.

Unrealistic promises. Beware of any company that promises to eliminate your debt or negotiate a settlement that sounds too good to be true. It probably is.

Missed payments. Rather than passing every payment you make on to your creditors, some companies take your first months' payments as a service fee. What they get, your creditor doesn't get!

By being a smart shopper, Jenny got the credit counseling she needed. She took control of her household budget, negotiated payment plans, and paid off her debts