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Debt Settlement May Not Be a Bright Idea

By Faye Mergel
Published: Thursday, January 28th, 2010

It has been weeks since consumers finished listing their New Year’s financial resolution but many of them are still months away from being able to remove those Holiday debts off their credit report. This situation though is hardly unusual.

INGMRF-00005084-001In October last year, 13.5 million American consumers were still grappling with the credit card debts they acquired during the 2008 Holiday season. There is, however, a little twist on this year’s financial situation for consumers: the implementation of new federal laws that regulate the banking and credit industry.

While these rules are aimed at protecting consumers, analysts are afraid that they may have unintended consequences that can harm Americans. Some are already blaming the CARD Act for the hiking of rates by banks and the cutting of some bank privileges such as bonus cards and free checking accounts. Banks have also re-introduced annual and inactivity fees on their credit cards, leaving consumers anticipating for more fees this year.

As debts become almost unbearable to consumers, many are tempted to seek the help of settlement companies which claim they can negotiate debt reductions up 50 percent or greater. Debt settlement or arbitration is a process where a creditor agrees to receive less than the balance owed yet considers the debt to be fully paid.

However, experts warn consumers that debt settlement firms do not always do as they promise and they often require high fees. Settlement firms may charge 13 percent to 35 percent of the total debt and may even require clients to pay those fees upfront. This means consumers will have to pay the arbitration fee even if their debts have not been negotiated yet. In cases where the debts have not been reduced as promised, consumers will have a lot of difficulty getting their money back.

Aside from its high costs, consumers are also warned that debt settlement could adversely impact their credit report.  If a borrower pays through settlement, it is most likely that the transaction will show up on his credit report as “Paid through Settlement.” This note on a credit report will affect one’s ability of getting loans and opening credit cards in the future.

Instead of seeking help through debt settlement, experts advise attending credit counseling instead. There are many non-profit organizations that offer the services. During debt counseling, participants are taught how to evaluate their personal finances and to establish a budget plan that will help them pay off their debts without damaging their credit.

Consumers who attend such activities often start by checking their credit report, which everyone is entitled to get for free once in every twelve months.

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