Using a debt settlement company can be hazardous for your finances

Due to their low success rate and high costs, debt settlement companies should be avoided.

If you are struggling to repay debts, you know that your situation seems desperate. Because of your seemingly hopeless situation, you may think that turning to debt settlement companies that are advertised on late-night television would be a good idea. However, the truth is that many of these companies fall far short of their promises to help you with your outstanding debts, and leave you worse off overall.

The Federal Trade Commission highlighted this fact in a recent investigation into these companies. The agency found that debt settlement companies fail at reducing the debts of their clients 90 percent of the time. The reason for the high failure rate is found in the tactics used by these companies.

Nearly every debt settlement company advises its clients to stop making payments towards their debts, so the company can use this as leverage to force creditors to accept less than the full amount owed to settle the debt. Unfortunately, this bold tactic often backfires, making the client's dire situation even worse.

For one, many clients of debt settlement companies are hit with interest and late fees as soon as they stop payment as instructed, causing their outstanding debts to grow significantly. In addition, the nonpayment of the debt may cause creditors to take more aggressive (and unpleasant) tactics to collect the debt, such as filing a lawsuit or instituting foreclosure proceedings.

Even if the debt settlement company is successful in working out a deal with the creditors, clients can still be put in a worse position. They can face harassing phone calls, as creditors are under no obligation to stop, even if the client is making payments towards the debt. Additionally, if any of the debts are forgiven, the client can be hit with tax liability, as any debt that is forgiven is considered to be income under the law.

Consider bankruptcy instead

Regardless of whether the debt settlement company is successful, just working with one can hit you in the pocketbook. They are for-profit enterprises that charge for their services, even if they are unsuccessful at reducing your debt. In many cases, the fee for their services is 15 percent of the debt owed or higher.

Unlike debt settlement companies, bankruptcy is a sure thing. Once you file bankruptcy, all foreclosure attempts, collection calls, accruing interest and lawsuits are immediately halted by the automatic stay. During the bankruptcy process, most of your debts are completely wiped away or reduced. However, unlike forgiven debt, it is tax-free. Additionally, compared with the costs of working with debt settlement companies, the fee to file bankruptcy is very reasonable.

If you are faced with mounting debts that you have little hope of repaying, you have options. An experienced bankruptcy attorney can go over your options with you and recommend the best way to get you back on your feet.