Is Debt Relief Real? Or Is It a Scam?

Should You Trust Debt Relief Programs?

While some debt relief programs deliver on promises to lower the total amount of money that you owe to creditors, you should always approach them with caution.

In 2023, Americans reported more than $62 million in losses incurred from mortgage foreclosure relief and debt management fraud [*]. 

Even legitimate debt relief options come with risks. When debt relief works, it can reduce the amount of debt you need to pay down and consolidate multiple debts into a single debt payment. But debt forgiveness programs also charge high fees to negotiate with lenders on your behalf, and they may even create tax problems for you.  

For example, if a debt buyer files a 1099-C — Cancellation of Debt form — for debt over $600, the Internal Revenue Service (IRS) could add the forgiven debt to your taxable income [*]. Canceled debt is only exempt in certain situations, such as in a Title 11 bankruptcy case or when the taxpayer is insolvent [*].

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How Do Debt Relief Programs Work?

To have creditors and lenders reduce the amount of debt that borrowers have to repay, debt relief companies use simple — and sometimes effective — methods.

As an example, here's how the debt settlement process works for National Debt Relief, an A+ accredited company as per the Better Business Bureau (BBB) [*].

• It advises you to stop all payments to creditors.
• It opens an escrow savings account in your name and lays out a new consolidated payment plan — often with lower payments.
• All payments go into the escrow account while the company negotiates a repayment plan with creditors.
• The company pays the creditor a lump-sum from the escrow account when a settlement is reached and passes along the new repayment terms to you.

While every company is different, most for-profit debt relief organizations promise some or all of the following:

• Reel in your debt and get a firm grasp on your personal finances.
• Consolidate debts to help you keep track of your financial situation.
• Reduce the amount you owe on your total debt and monthly payments.
• Obtain lower interest rates to help you repay loans faster.
• Offer more suitable payment terms, such as extended terms and lower monthly rates.
• Refinance loans, which might improve interest rates or switch the rate type (fixed or variable).

In most cases, debt relief companies focus their services on personal unsecured debt, such as high-interest credit cards and lines of credit, medical bills, income tax payments, and personal loan debts.

While some companies offer assistance and modifications for secured loans, such as auto loans and mortgages, debt cancellation in these cases often ends in foreclosures and repossessions [*].

⛳️ Related: How To Prove a Debt Is Not Yours (and Dispute It) →

The Downsides To Enrolling in a Program:

Despite the promises, debt relief programs can carry some serious consequences for those that enroll. The following are a few of the negative impacts of debt settlement:

• Plummeting credit scores. Missed and late payments are recorded on your credit report and can tank your credit score and worthiness. The longer you withhold payments, the more your credit score suffers. 
• Damaged credit report. Adverse entries like debt settlements stay on your credit report and hurt your credit worthiness. These accounts may be listed as "Settled," "Charge-off," or "Paid" and remain on your credit report for up to seven years. Bankruptcies remain for up to 10 years or more [*].
• Increasing taxable income. Canceled, discharged, and forgiven debt is taxable, as per the IRS [*]. Not only do you pay to have your debt discharged; you also pay taxes on the discharged amount as if it were ordinary income.
• High account fees. Debt relief companies often charge fees for setting up and administering your savings account. These fees typically are added onto the post-settlement fee.
• Sizable service fees. Service fees vary, but they tend to range between 15% and 25% of the total debts enrolled in the program [*]. You must pay these fees in addition to the debt payment to which you agreed.  
• Additional fees and penalties. There's no guarantee that the late fees, interest, and penalties you ran up during the debt settlement process will go away.
• Debt may be sold to a collector. Instead of interfacing with the debt relief company, creditors may sell your debt to a collector. On top of managing persistent creditors, you may incur fees and adverse entries on your credit reports, such as “In Collection” and “Paid Collection.” Note: Medical debt with a reported balance under $500 may be exempt [*].
• Legal action. Creditors may sue you for the debt you owe, which could result in your wages being garnished. For this to happen, however, the creditor must receive a court-approved garnishment; federal benefits may be exempt [*]. 
• Locked accounts. When involved in a debt settlement, any indebted accounts enrolled in the program may be locked. This is particularly troubling when that includes your credit cards.
• The settlement may not work. Some creditors refuse to work with settlement companies, which renders their services useless. Meanwhile, you're still responsible for the full debt and any late payment fees.
• May require litigation assistance. Debt relief services don't normally include legal assistance. You'll have to pursue that on your own if, say, you’re forced to file for bankruptcy.

⛳️ Related: How To Dispute Debts in My Name (That Aren’t Mine) →

Debt Relief Scams and Warning Signs

The Federal Trade Commission (FTC) received more than 62,000 reports of debt management and other related scams [*]. What these scammers want and who they target can vary wildly, even within the same type of scam. 

For example, the Credit National Assist scam and Financial Hardship Department scam both offer pre-approvals for financial support.

These scammers call or email and ask you to download a form, click on a link, or furnish information over the phone to complete your application. Any information you give will be stolen, and any download or clicked link could infect your device. 

Last year, the FTC shut down two major student loan forgiveness scams — both groups claimed to represent the U.S. Department of Education [*]. They lob people with offers of attractive repayment programs and promises to forgive student loans for a fee. What they really want is your information or your money, and they offer nothing in return. 

You can avoid debt relief and credit repair scams by paying attention to the following red flags:

1. Unsolicited sales pitches offering debt relief services. If you didn't directly apply for debt relief, you shouldn't be receiving any offers. Cold calls can be dangerous and should never be entertained. 
2. Guarantees that creditors will forgive your debt. Legitimate debt relief companies never provide guarantees. They may offer insights, but they cannot predict how creditors will respond to settlement offers.
3. Claims that they can stop all debt collection calls and lawsuits. You can stop debt collector calls yourself with a simple request [*]. However, this does not get rid of the debt, and it does not prevent lawsuits.
4. Suspicious details and practices. First, the company should have easy-to-find and verifiable contact information. It should also follow several best practices, including offering free consultations and allowing you to contact creditors throughout the process.
5. Requests for upfront fees. No debt relief company should request upfront fees. Under the Telemarketing Sales Rule (TSR), debt relief companies cannot legally charge upfront fees before resolving a debt [*]. However, people who enroll online or in person may not have the same protections [*]. 
6. Does not disclose the full extent of the service. The TSR also mandates that debt relief companies provide specific details on their process, including the cost, the amount of time needed for results, how the escrow or savings account works, and any potential consequences [*].
7. Claims that the money in your settlement account isn’t yours. The money you pay into a savings or escrow account — including any interest accrued — remains yours until a settlement is reached [*]. You have the right to withdraw it whenever you want, and any company claiming otherwise should be avoided.
8. Offers only negotiation services. Debt relief companies should offer something more than just negotiating with creditors on your behalf. The best and most useful services come with consultations, financial education, and resources that you can access throughout the process.
9. No oral or written settlement agreement. For debt settlements to go through, they must be agreed upon by the creditor and the borrower. While oral and written agreements are eligible, opt for written agreements for the best protections.
10. Sells government programs or legal loopholes to eliminate debt. While some federal debt assistance programs exist, there are no options or loopholes to which debt relief companies have access that you do not. Companies that suggest otherwise are probably lying.

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⛳️ Related: Does Credit Repair Work? What To Know Before You Sign Up →

If Not Debt Relief Companies, Then What?

With household debt reaching $17.5 trillion in the final quarter of 2023, Americans need useful alternatives to questionable debt relief programs [*].

While a home equity line of credit (HELOC) or home equity loan might come to mind, these may not be the best options for you or your situation. Consider the following:

• Unsecured debt can be paid down over three to five years through a chapter 13 bankruptcy, or erased completely with a chapter 7 bankruptcy [*, *]. A bankruptcy with secured debt in a HELOC or home equity loan may lead to a property foreclosure.
• If your debt-to-income ratio exceeds 50%, you will struggle to pay down what you owe, regardless of the interest rate or consolidation.

If you want to avoid secured loans and debt settlement companies, explore the following options:

• Non-profit credit counseling. Credit counselors can help you take control of your debt situation, such as by organizing an actionable debt management plan (DMP) with lower interest rates and monthly payments. You can find a list of accredited credit counseling agencies in the National Foundation for Credit Counseling's Agency Finder.
• Debt consolidation loans. A debt consolidation loan allows you to exchange multiple types of debt for a single loan debt. Not only does this make repayment easier; it can also lower your interest rates and monthly payments.
• Debt relief through bankruptcy. Depending on the situation, debts may be discharged through bankruptcy. With a chapter 13 bankruptcy, you pay off some debts through a court-approved payment plan. With a chapter 7 bankruptcy, your debts are discharged and your assets are liquidated. 
• Negotiate a debt settlement yourself. You can always settle a debt yourself by calling your creditors and suggesting a payment plan. Your proposal might include one discounted lump sum or smaller regular payments. During the process, be sure to confirm that you owe the debt, figure out what you can realistically offer, explain your situation, and record the agreement.
• Credit card refinancing or balance transfer cards. You can refinance your credit card debt in several ways, but a balance transfer credit card is one of the most popular. The low interest rates of these cards make them useful for consolidating your high-interest credit card debt in one place. However, the cards may feature only temporary low interest rates, have balance transfer fees, and impose steep missed payment penalties.
• The Servicemembers Civil Relief Act (SCRA). The SCRA offers servicemembers debt protections in order to ensure they can devote themselves entirely to their service. The protections cover reduced interest rates, appearances and judgments in lawsuits, home foreclosures, repossessions, and lease terminations [*]. However, the SCRA only protects you from pre-service obligations, and refinancing or consolidating your debt while on active duty may disqualify them.

Before You Enroll for Debt Relief, Do This:

Enrolling with the wrong debt relief program can be disastrous. This means that you not only have to avoid the ineffective companies, but you also have to protect yourself from loan fraud and scams.

Before enrolling in debt relief, verify the company's reputation with the following checks:

• Look for consumer complaints. Read what others are saying about the company in the Consumer Financial Protection Bureau's (CFPB) Consumer Complaint Database or the Better Business Bureau's public records.
• Call your state’s attorney general. Inquire if the state has taken action or investigated any complaints against the debt relief company.
• Check with the FTC. Find the latest news on debt relief and credit repair scams on the FTC website, or view the list of companies banned from debt relief.

Also ensure that the company discloses required information, such as:

• How you qualify. Find out how much and what kind of debt relief you need, how much you need in the escrow account before a settlement offer is made, and how long that could take.
• The fees, conditions, and terms of services. Learn about specifics like account fees, cancellation policies, and how the account interest and withdrawals work.
• Potential tax and credit implications. Confirm how your taxable income and credit score might be affected by this process.

Even after taking every precaution, you could still fall victim to a debt relief scam. For better protection, consider Aura. Aura keeps a constant eye on your credit file, financial accounts, and identity — alerting you to any suspicious activity.

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