What do I need to know about debt reduction, debt consolidation, and credit repair companies?

Debt Reduction Companies

Many businesses out there will offer to reduce the amount of debt you owe. While this might sound like a good idea, there are two very important things you need to know about these businesses:

•	They do not help you improve your credit score.
•	They charge fees based on the amount of your debt and how much money they think they can save you. These fees can be as high as 33% percent. That is a very hefty fee. You could be better off using that money to pay down your debt.

How Debt Reduction Services Work
When you work with these businesses, they reduce the amount of what you owe by up to 60%. That means if you owe $10,000 in credit card or loan debt, a debt reduction service could reduce the amount you owe to $4,000. This reduction is called a settlement, and it will damage your credit score. Paying bills accounts for 35 percent (the largest part) of your credit score. If you “settle” to pay only 40 percent of your total debt, your credit report will reflect nonpayment for 60 percent of your debt. Also, those debts can be “charged-off” by your lender, adding another negative item to your credit report. A charge-off means your lender gave up trying to collect the debt and turned it over to a collection agency.

This debt-reduction strategy is based on the second-largest part of your credit score: the amount of debt you have. By reducing debt you can raise your score. But reducing debt by “settling” to pay less than you originally charged is different than “paying” for everything you charged. Settling your debts will hurt your score. Paying your debts will improve your score.

What debt reduction businesses may tell you that is completely untrue:
• “We can remove negative items from your credit report.” No one can remove accurate negative information. Period.
• “We can make you debt-free today.”
• “We can erase all of your debts.”
• “We’ll stop collectors from calling you as soon as you start working with us.”

What debt reduction businesses may not tell you that you need to know:
• Debt reduction businesses can only reduce certain kinds of debt, such as credit card debt.
• They cannot reduce the amount of your mortgage, school loans, child support, or back taxes owed.

Use these businesses with extreme caution. You can probably accomplish more on your own— and save a lot of money and improve your credit.

Names of Debt Reduction Businesses
You’ve probably seen ads for these businesses under a variety of names:
• Debt Management
• Debt Elimination
• Debt Relief
• Debt Reduction
• Debt Workout
• Debt Settlement
All of them offer to reduce the amount of debt you owe.

Tips for Avoiding Shady Debt Reduction Services
Steer clear of debt reduction companies that:
•	Guarantee they can remove your unsecured (credit card) debt.
•	Promise that unsecured (credit card) debts can be paid off with pennies on the dollar.
•	Require substantial monthly service fees.
•	Demand a portion of your savings as payment.
•	Tell you to stop making payments to your creditors.
•	Tell you to stop communicating with your creditors.
•	Require you to make monthly payments to them, rather than to your creditor.
•	Claim that creditors never sue consumers for non-payment of unsecured (credit card) debt.
•	Promise that using their system will have no negative impact on your credit report.
•	Claim that they can remove accurate negative information from your credit report. Nobody can remove accurate negative information from your credit report.

Debt Consolidation Companies

Debt consolidation is the process of lumping all of your debts together so you have one monthly payment. Businesses that offer this service usually offer loans at lower rates than the APR (annual percentage rate) you’re paying on your credit cards. In exchange for the loan you take with the debt consolidator, it pays off your debts. You would now make a monthly payment to the debt consolidator instead of your credit card companies.

What you need to know when you work with these companies is the difference between secured and unsecured debt. Homes and car loans are secured debt. That means that if you default on these loans, lenders can take your home (foreclosure) or car (repossession) from you. Your credit cards are unsecured debt. If you default on your credit card payments, your lender cannot take anything from you—it will, just do everything it can to collect payment.

What some debt consolidators do is make the loan they give you a secured loan. That means if you default on loan payments to your debt consolidator, it can take your home, your car, or whatever possession of yours they “secured” to the loan. Most of these secured loans are tied to homes. If you default, this could be disastrous and cause you extreme hardship. Beware.

Credit Repair Companies

Avoid “credit repair” companies. They will charge to improve your credit by doing the things you’re learning to do for yourself on this Web site.

Many credit repair companies make false claims, such as “We can remove negative items from your credit report.” This is untrue. Nobody can remove accurate negative information.

For more information on companies claiming to repair your credit, read this article from the Federal Trade Commission (FTC): Credit Repair: Self Help May Be Best.