What about Credit Counseling or Debt Management Companies?
It is an unfortunate truth that not everyone offering to help you get control of your finances has your best interests (as opposed to their own) at heart. Indeed, the Consumer Federation of America conducted a study of this new breed of "non profit" organization, finding that many are essentially rip-off groups that pay their own fees and then leave debtors worse off than before. At best, they put a Band-Aid on the problem, at worse they exacerbate it.
See: Consumer Federation Blasts Debt Relief Agencies
In particular, consider the following before pursuing a debt management company rather than bankruptcy protection
1. Know exactly what their fees are
- How much of your payments go to their fees rather than your debts?
- Do they pay themselves first before paying your creditors?
- Do they guaranty any debt reduction? (Pin them down on this)
- What do they do if your creditor refuses to negotiate?
2. These arrangements only address unsecured debt
Oftentimes, debt management companies will siphon off your available cash to pay credit card debt (which is dischargeable in bankruptcy) while foregoing other debts that are not, such as home mortgages, car payments, tax debts, judgment liens, etc. The downside is that if you eventually have to file bankruptcy after failed "debt management" - which happens very frequently, you are now left in a worse financial position than before.
3. Most Debt Management Companies Have a Shockingly Low Actual Success Rates
Indeed, an evaluation of one prominent debt resolution company found: "Statistics provided by the receiver show that a shockingly low 1.4 percent of the consumers that entered NCC’s program completed it." Do not sign up with such a company without getting verified success rate statistics BEFORE you commit. Beware, fraud and deceptive practices permeate this industry.
4. Beware Tax Consequences
Even if a Debt Management company negotiates a reduction in the principle of your debts, you will likely get hit with a 1099 Tax form at the end of the year stating that you now owe taxes on all of that "income" from the "debt forgiveness." And again, if you still end up having to file bankruptcy because the "debt management" was unsuccessful (which is the case most of the time), tax debt generally cannot be discharged in bankruptcy for at least 2 years. On the other hand, through bankruptcy protection, all of these debts can be dealt with in a consolidated manner.
5. Beware Excessive Fee Scams
Debt management companies ask you to pay them several hundred dollars per month that they then, supposedly, pay to the creditors in resolution of your debts. But often the fine print says that in the event they are unsuccessful, they get to keep all of your money as fees -- this includes the money that you thought was supposed to go toward your credit card debt. So now you have the same debt you had before, but are out thousands more for nothing!
We are aware of many cases where individuals paid several thousand dollars to a "debt management" company, which was unsuccessful in any negotiations, and who then simply referred the individuals to a bankruptcy attorney, refusing to refund the several thousand dollars paid by the individual to settle their credit card debts. The company claimed that the fine print in their contracts allowed them to keep this money as fees.
6. "Debt Management" Can Hurt Your Credit
Be wary also that when a debt is negotiated down through "debt management," this is not neutral to you credit report, but actually adds additional negative information.
Furthermore, these companies generally advise you to completely stop paying your credit card bills in order to give them your money instead. If your credit score is reasonably good and you have been making most of your payments, this strategy will have the effect of DESTROYING your good credit. See "Credit Reporting" herein.
In conclusion, there are many pitfalls in pursuing assistance through a "Debt Management" firm, so be very careful if you choose to pursue this route.