Short answer: for-profit debt settlement companies try to get your creditors to accept a lump sum that is less than you owe, while you save up in a special account; these programs often encourage you to stop paying your creditors (FTC). Under the FTC's Telemarketing Sales Rule, a company selling debt relief by phone cannot charge a fee until it has settled at least one of your debts and you have made a payment under that settlement (16 CFR 310.4(a)(5)). The risks are real: while you save, your balances can grow with interest and fees, collectors can call or sue, your credit can be damaged, and forgiven debt may be taxable (FTC).
What the law requires
- No fee up front. No fee until the company has settled or changed the terms of at least one debt under an agreement you signed, and you have made at least one payment under it. When debts are settled one at a time, the fee for each is either a share of the total fee in proportion to that debt, or a fixed percentage of the amount saved (16 CFR 310.4(a)(5)(i)).
- Your account, your money. If you must save in a dedicated account, it has to be at an insured financial institution, the money and any interest are yours, the account administrator cannot be affiliated with the company or pay it for referrals, and you can quit at any time without penalty and get your money back, less fees already earned, within seven business days (16 CFR 310.4(a)(5)(ii)).
- Disclosures before you sign up. How long it will take to get results and when it will make an offer to each creditor; how much you must save before each offer; and, if the program relies on you not paying, that this will likely hurt your credit, may lead to collections or lawsuits, and may increase what you owe through fees and interest (16 CFR 310.3(a)(1)(viii)). If a company did not tell you these things, the FTC says walk away (FTC).
A worked example
Example only; the settlement percentage, the fee and the deposit are made up to show the math. A $10,000.00 credit card balance at 22.36% is enrolled, and you stop paying it while you deposit $350.00 a month into the dedicated account for 24 months. Interest is added monthly; late fees, which would add more, are left out.
| Step | Amount |
|---|---|
| Saved in the account after 24 months | $8,400.00 |
| Card balance after 24 months of no payments | $15,575.02 |
| Creditor accepts 50% of that balance | $7,787.51 |
| Amount saved under the rule: $10,000.00 enrolled minus $7,787.51 paid | $2,212.49 |
| Company fee: 20% of the amount saved | $442.50 |
| Total paid: settlement plus fee | $8,230.01 |
| Left in the account | $169.99 |
| Balance forgiven by the creditor | $7,787.51 |
Even when it works, you pay $8,230.01 on a $10,000.00 debt after two years without payments, with the damage to your credit that comes with that. If the creditor refuses, or sues before you have saved enough, the balance has kept growing. And the $7,787.51 the creditor forgives may count as income: a canceled debt can be taxable (IRS); see cancelled loan debt and taxes. This is not tax advice.
The risks
- Many people cannot keep up the deposits long enough and drop out; they lose the fees already paid on settled debts, still owe the rest, and their reports probably show late payments (FTC).
- Creditors do not have to agree to settle, you may not be able to settle all your debts, and the process can take years (FTC).
- Collectors may keep calling while you are in the program (FTC). Your rights with them are in debt collector rights on a loan; what a charge-off means is in what a charge-off means.
- You can try to settle a debt yourself, without paying a company; get any agreement in writing (FTC).
Red flags
- A fee before any debt is settled (16 CFR 310.4(a)(5)).
- No clear answer on how long it will take, how much you must save, or what happens to your credit (16 CFR 310.3(a)(1)(viii)).
- A promise that every creditor will settle; some companies make promises they cannot keep (FTC).
- An account you cannot withdraw from, or one run by the company itself (16 CFR 310.4(a)(5)(ii)).
Before you sign up, compare a nonprofit credit counseling plan; see debt management plan vs consolidation loan. If you have a problem with a company, see how to file a loan complaint. This guide explains federal rules in general terms and is not legal advice.
Start your loan request How our service works
Disclosure: Modern Lending Solutions is not a lender, loan broker or agent for any lender or loan broker, and does not make credit decisions. Any compensation we receive is paid by participating lenders, only for advertising services. This guide is general information, not financial or legal advice.