Why Debt Settlement Often Doesn’t Work

Get Control of your DebtThere are a lot of companies offering to settle debt these days.  You can hear advertisements on the radio any time of the day offering to reduce your debt by 50% or more.  For some debtors debt settlement might be a good option but for most it is not.  I’ll give an example as an explanation of why the math involved in debt settlement simply doesn’t work.

John has five credit cards.  Each has a balance of $10,000, for a total credit card debt of $50,000.  John has been struggling with making the minimum payments and as a result, made a payment late.  In response to the late payment, all five credit cards increased their interest rate to 30%.  John contacts a debt settlement company that agrees to help him settle one of the credit cards for $5,000.  It takes John six months to save the $5,000 needed to settle that debt.  But while he is saving that money his other four credit cards are still gaining interest and the balances have increased $6,000.

At the end of the six months, John now has four credit cards with balances totaling $46,000.  However, we haven’t discussed what the debt settlement company charged John to settle the debt for him.  They didn’t work for free.  In addition, the creditor reported the cancelled portion of the debt to the IRS as income, so now John has to pay taxes on the $5,000 that was forgiven by the creditor.  In addition, that income increased his total income and has caused him to be in a higher tax bracket, paying a higher tax rate on all of his income.  At the end of the six months, John has one less credit card but still has about the same amount of total debt.