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TheStreet Open House

Too Many Risks to Go With a For-Profit Debt Settlement Company

NEW YORK (TheStreet) -- It seems like a no-brainer: When a problem gets overwhelming, hire a pro to sort it out. Like when your debts snowball out of control.

But not so fast. A study by the Center for Responsible Lending shows that turning to a for-profit debt-settlement company can actually make matters worse.

The center describes the debt settlement option as a kind of leap into the void, and instead of finding a safety net, you could find yourself smashed on the rocks below. That's because these firms typically require that you stop making payments on your debt before they start negotiating with the creditors. If the settlement talks fail, you could well be on the hook for even more payments, penalties and interest.

For-profit debt-settlement firms typically charge fees of 20% to 25% of the debt involved, with credit card debt the most common type of debt covered. The fee is usually due once the firm negotiates a settlement, and is paid even if the settlement later falls apart, which can happen if the consumer gets behind on subsequent payments to creditors. In addition, the debtor may owe federal income taxes on any debt that is forgiven.

Also see: 8 Pieces of Advice Grads Will Need for the Rest of Their Lives

Despite a government crackdown on upfront fees long charged by settlement firms, big risks remain, the center says, noting that "a substantial share of consumers will likely be unable to settle enough debts to experience a positive change in financial position relative to their condition at the time of enrollment" with a debt-settlement firm.

Among the risks: the creditor may refuse to negotiate, and an agreement that falls apart later can result in further damage to the consumer's credit rating and trigger lawsuits.

If for-profit debt firms are a risky option, what's the alternative?

Also see: When It Makes Sense to Take a Loan From Your 401(k)

The center says consumers can negotiate directly with creditors, trying to reduce monthly fees, or even to get size of the debt reduced. Another option is to enlist the help of a nonprofit credit counseling organization.

With these approaches, the consumer does not have to default on debt before the process can begin, eliminating the biggest risk of signing up with a for-profit settlement firm.

You can also tackle the problem on your own with a few tried and true strategies such as using any extra cash to pay down debts that charge the highest interest rates, making the minimum required payment on low-rate debts until the more costly ones are out of the way.

For many consumers struggling with debt, the first step is simple budgeting, to find expenses that can be trimmed so more cash can go to pay debts down.

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