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The Debt Consolidation Quagmire: Digging a Bigger Hole

Over the past 5 years, debt consolidation companies have exploded in popularity. One of the most common questions we receive during consultations is, “Why should I file for bankruptcy when I can do debt consolidation?”

First, it is important to clarify what kind of programs constitute debt consolidation. For us, debt consolidation companies are usually the ones that advertise on TV, Radio and the Internet. They will typically say something along the lines of, “Don’t ruin your credit for 10 years by filing for bankruptcy….Do Debt Consolidation with our company and settle your accounts for less.” These companies usually have a generic first word in their name followed by the term “……Debt Relief”. Sometimes, even a law firm will offer these services. However, what is common with all of these companies is that you will make a monthly payment to them and over time they will collect your money and use it to settle your accounts with your credit card companies and possibly even other creditors.

All of it sounds like a great solution. So what’s the problem? The problem is that these kinds of programs and companies are essentially scams. They prey upon the natural fear that people have of bankruptcy and use it to milk their clients out of thousands of dollars with little chance of success. All of these programs rely on the patience, cooperation and consent of all your different creditors….which is all highly unlikely.

The issue with these debt consolidation companies is that they will place you on a 4+ year payment plan. Usually the payment is a little less (not much) than what you were paying to your creditors…so you think that you’ve made a good, responsible decision. Some of your smaller accounts may even be settled within a year. However, as time goes on you will realize that few if any of the significant debt has been settled.

Approximately 1 to 2 years after you start the program, it is likely that you will be sued by a creditor who has not been paid a penny during that time. Once you have been sued, your debt consolidation company will charge you additional fees for having attorney representation in your new lawsuit.

Shortly after you pay for attorney representation (which means some attorney will agree to pay the amount in full over a payment plan), the debt consolidation company will start to increase your monthly payment amount and possibly even extend out your payments past the original 4 years in order to provide full payment for the lawsuit and other debt it has not been able to settle.

Meanwhile, during this time, all your debt has increased due to interest and fees being applied. And your credit score is near the bottom for missed payments and defaulted accounts, with little hope of a quick recovery.

In the event that some debt is settled for less than what you owe, your creditor will file a 1099C with the IRS and you will be expected to pay income taxes on the debt you did not have to pay to your creditors.

We know debt consolidation is essentially a scam because nearly half of our bankruptcy clients come from failed debt consolidation plans. Many times, they end up filing for bankruptcy because the debt consolidation company tells them to do so.

We have heard all the different stories of how they fail. One recent client of ours had signed up with a debt consolidation company where she would have paid the company nearly $18,000 in total fees to settle her credit card debt of $30,000. That is unconscionable.

In closing, be very careful what you sign up for with these debt consolidation companies. They are rising in popularity and its a billion dollar business.

If you are in facing financial difficulties due to debt, talk to a bankruptcy attorney first. Remember a bankruptcy attorney has a fiduciary duty to look out for your best interest and to explain all your bankruptcy and non-bankruptcy options to you.

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