Debt management companies are showing up everywhere. Unlike debt consolidation where you take out a loan and pay off your various other debts, debt management companies help you “manage” your debt by taking one payment from you and distributing it to all of your creditors. Because Americans are buried in debt, the debt management business has become one of the fastest-growing industries today. They prey on the consumer’s desire to do the right thing. Consumers know they borrowed money or used services, and they feel obligated to pay it back.
Unfortunately, this attempt to do right by your debts usually lands you in a worse situation than if you had simply filed for bankruptcy in the first place. Debt management companies are not regulated as strongly as they should be. They usually call themselves “non-profit,” which obscures the fact that they are in the business of making money. They make “agreements” with your creditors, but you have no recourse if the creditor changes its mind and wants you to pay as you originally agreed. And unfortunately, negotiating new agreements often results in collection efforts by creditors who aren’t willing to negotiate.
This is how these debt management companies work: They tell a consumer to stop paying their bills. The consumer instead pays the money into an account overseen by the debt management company. This puts the consumer’s credit accounts into default status and starts the process of collection, which results in delinquencies appearing on the person’s credit reports. It also causes collection efforts, such as collection calls and letters, and ultimately judgments. The creditors may also refer the accounts to collection agencies.
The sad truth is that many creditors, once they figure out that you are trying to consolidate your debt, take collection action against you. The debt management company may have negotiated favorable settlements with several of your creditors, but once creditors knows that a debt management company is involved, creditors who have not negotiated settlements can wait until most of the consumer’s debt is settled, then sweep in and demand full payment, or simply refuse to strike a deal.
These creditors who refuse to negotiate can get all of your remaining money, or not settle at all. Once a consumer’s debt has been somewhat reduced, the creditors who did not negotiate have no incentive to take less than the full amount owed. The result is that the consumer may end up with delinquencies, charge offs, and collections on their credit report, and still have to file for bankruptcy. We have heard the story time and time again where someone was making a large lump sum payment to a debt management company for months or years, and then they were sued and their wages garnished anyway.
Sadly, debt management is just as bad for your credit score as bankruptcy. Companies like Consumer Credit Counseling Service can help you get better interest rates and lower payments, but at a price. When you use one of these companies and then try to get a Conventional, FHA, or VA loan, you will be treated the same as if you had filed Chapter 13 bankruptcy. Mortgage underwriting guidelines for traditional mortgages will consider your credit trashed.
Finally, if any of your debt is forgiven, you could have to pay income tax on the forgiven portion of your debt. If you do not budget for this when creating a debt management plan, you could come out owing instead of being debt free.
Filing for bankruptcy protects you from collection efforts after you file. It stops interest, fees, and penalties from accruing. Bankruptcy eliminates and income tax event on your forgiven debt. Once you file for bankruptcy, your credit score has the chance to gradually increase as you get back on your financial feet.