(Jonathan is a credit counselor at ClearPoint.)

I’ve counseled numerous clients seeking advice after debt settlement companies haven’t delivered on their promises.

One client worked with a debt settlement company that collected funds, but made no payments to the creditors and then refused to give the client a refund. Another received a summons from a creditor seeking legal judgments/wage garnishments. After a debt settlement company advised another client and her husband, that creditor agreements were in place, hey complained of receiving a summons seeking wage garnishments. A different client completed a debt settlement program and then found out he had a huge tax burden for the forgiven debt. Due to misleading promises, these situations are all too common.

Another misconception is that when debt settlement companies make agreements with the creditors, they will not pursue legal action. Debt settlement programs aren’t successful until creditors accept the settlement company’s offers which can take months, if not years. While they negotiate with creditors, chances are that creditors will seek legal action against you and debt settlement firms cannot stop creditors from doing so. More than likely they will obtain a wage garnishment.

Debt settlement agencies often advertise that they’ll settle your debts for pennies on the dollar. They make it sound like they are part of some sort of government stimulus program or bail out. The truth is that there is no such government program. In fact, many times the consumer’s balances increase due to late fees and high interest charges and by the time they settle their debt, the reduced amount isn’t much less than what was originally owed. On top of that, settlement companies often charge hefty fees.

Debt settlement hurts your credit. Lack of payments can cause your accounts to be placed in collections and charged off. If creditors report that your account was settled rather than paid in full, your credit will suffer. Negative remarks on your credit report last for seven years.

Lastly, many settlement agencies do not advise their clients of the possible tax implications associated with using a settlement program. More often than not, when debt settlement programs are successful and a client is able to settle their debts for less than what was owed, clients actually end up end up owing debts to the IRS. Most find out after the fact that they have to claim any difference in what was owed and the settled amount as income on their taxes.

Thankfully, new federal rules aimed at the debt settlement industry go into effect on Monday, October 27, 2010. Under the stricter rules, debt settlement companies doing business by phone can’t make misrepresentations false claims. They must disclose the possible issues related to settlements, like the negative impact to credit scores, tax implications, and the possibility of legal action. Debt settlement companies will be also be check on their fees and must give refunds to clients who discontinue their programs. See the Federal Trade Commission’s new rules for more information.

[Read What is Debt Settlement? to learn more about this topic]

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