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Debt Settlement Deals Come With Big Risks

NEW YORK (TheStreet) -- On the surface, debt settlement deals sound like an answer to a financially struggling consumer's dream.

You can cut a deal with a lender to pay a lump sum -- usually well below the actual amount of the debt -- and remove that debt from your life forever.

But up to 80% of all debt settlement deals may never close, no matter what the lender or creditor says, and many debt settlement deals leave consumers owing more money.

A study from the Washington, D.C.-based Center for Responsible Lending clarifies the risk associated with the deals, especially when working with third-part debt settlement companies, and concludes that such deals represent a "risky strategy" for consumers that often leaves them "more financially vulnerable."

Also see: Bank Savings Low, Americans Dip Into Retirement Savings

"The idea is simple: Debt settlement companies offer to negotiate down the outstanding debt (usually from credit cards) owed to a more manageable amount so that a consumer can become debt free," the CRL says. "Unfortunately, debt settlement carries significant risks that may result in consumers becoming even worse off."

The list of things that can go wrong is lengthy, the study finds. Lower credit scores, high fees, rising interest rates, tax liability and potential lawsuits are all on the docket when considering a deal. Some creditors refuse to negotiate with debt settlement companies, and the CRL says consumers must be able to settle "at least two-thirds of the debt they enroll in a debt settlement program" to see a benefit.

Even after dealing with all of those potential pitfalls, there still is no guarantee the consumer won't fall back into default, leaving a bigger financial mess to clean up.

Also see: 7 Steps to Better Credit for the 40% Who Don't Understand Their Score

"The implications of defaulting on debt are not to be taken lightly," says Leslie Parrish, co-author of the report and a research director at CRL. "When a consumer stops making payments on a debt, not only is she vulnerable to fees and an increased interest rate, the reporting of this delinquency to credit bureaus can impact her credit score for years; she also may be sued by her creditor."

The Center reports that a consumer, on average, winds up owing more than 20% more than he or she did before, after participating in a debt settlement program. That's the debt balance alone and does not include fees and any potential tax liability linked to a debt settlement deal.

The Center calls for the government, via the Federal Trade Commission, to step in and get more aggressive about debt settlement deals and debt settlement companies. The CRL also is asking individual states to step in and make sure all debt settlement companies are regulated, and for potential customers to make sure they are good candidates for a debt restructuring campaign.

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