Weighing the Benefits of Debt Settlement

When consumers with mounting debts get desperate, they often turn to what can seem like their last, best hope: debt settlement companies.

Those companies are taking on an increasing number of clients as more consumers find themselves unable to pay their bills. Bankruptcy filings are up 30 percent over last year, and many consumers have so much debt relative to their income that debt settlement companies decline to take them on as clients. (Credit counselors, who focus on financial literacy and rehabilitation rather than negotiating lower payments, often work on those more severe cases.)

For a fee, struggling consumers can hire a company like Debt Settlement USA, which currently works with around 16,000 clients. Jack Craven, president of Debt Settlement USA, says his clients have between $12,000 to over $300,000 of unsecured debt, which includes credit cards, overdue rent, and utility bills. U.S. News asked Craven to explain the ins and outs of his business. Excerpts:

How does debt settlement work?
People call us to ask about signing up for the program. We help them start the process of saving money and then contact their creditors [on their behalf]. We usually get creditors to accept a 40 to 60 percent settlement rate. This month, we're getting a 37 percent settlement rate. The companies are willing to accept that because otherwise, they could get nothing. Generally, at that stage, people are going to go bankrupt, and it's hard for banks to know what's going on. Hardship clients [people who are experiencing major life challenges that make it impossible for them to pay their bills] don't have much money, and sometimes the bank never gets paid.

Do you also help teach clients how to save money?
We don't give legal advice, but we do tell people how they can save money. We go through their debts and pick which ones they should do first.

Does it hurt a person's credit score to do that?
It can hurt it temporarily, but in the long run, it's better to get out of debt. Around 25 percent of clients who get out of debt do it in a year or less. The other 75 percent do it in a two- to three-year time frame. It takes time to build up funds. We call clients every 25 days, whether we need to or not, to check in.

We urge people to keep one credit card [so they can build their credit score back up by making regular payments]. It usually takes six to 12 months before they can start rebuilding their score.

How much does your debt settlement service cost?
We charge 14 percent of unsecured balance you bring in, payable over 11 months, plus a $29 application fee. So for someone with a $10,000 debt, they will pay us $1,400.

Do you ever turn customers away?
When we first talk, we go over their debts and income. If they don't have enough, we say, "You can't afford to be in a program like ours. Maybe consumer credit counseling would be better."