I’ll discuss both here because there are so many commercials, advertisements and misinformation out there that its worthwhile taking a deeper look.

First, a word of caution. There are many unscrupulous companies out there (usually located in the middle of Nowhere State) that promise all sorts of results. Namely, that you will pay off all your debt within 3-5 years or less and for a “fraction” or for “pennies on the dollar”. More often than not, the whole process can be a nightmare and you could end up owing “150 pennies on the dollar.”

The Typical Debt Consolidation or Reduction Company

1. They do a lot of heavy advertising, promising that; you would pay off your debt in a relatively short period of time and for a fraction of what you owe;
2. You sign a contract, which most people don’t read;
3. You make payments to that company and they’ll take care of the rest.
4. You make the monthly payments and find out later that you have been served with a lawsuit.

What really happened is that the company (per their contract) gets to keep the first monthly payments as their fee (typically $5,000 to $10,000). After that, the company saves your monthly payments and then pay a portion to each company (either in payments if consolidation or lump sum if reduction).

Problem #1: You have to stop making payments in order to even begin this process. What happens if you stop making payments ? It still ruins your credit. Not much better than how a bankruptcy mars your credit.

Problem #2: There are some companies that actually try to work out deals with your creditors, but there are just as many that will just take your money and do nothing.

Problem #3: You literally start to run out of money by the time the company has taken their fees. This is just the nature of the beast because humans are generally overly optimistic about their ability to pay off debt.

Problem #4: The reduction or consolidation depends on whether that particular credit card will make these deals with the company you hired. THEY DO NOT HAVE TO MAKE ANY DEALS. PERIOD.

Problem #5: Even if you had a debt reduced, the amount of reduction is taxable income. This is known as “forgiveness of debt” income. There is a way to ask the IRS to declare that you are insolvent. But if that was the case, why didn’t you just file bankruptcy and save all that money ? Your credit is ruined anyway.

Problem #6: The biggest problem is this: By the time the company you hired gets around to settling a deal, the total amount that is due probably has doubled. Once you default (stop paying), a much higher interest rate (sometimes as high as 28%) kicks in. Then there are late charges, etc. So, let’s say the company got a 50% deal for you 6 months later on a $10,000 credit card. The total is closer to $12,000. You are paying $6,000, which is only a reduction of 40% from the original. Then you get hit with a 1099-C income from the IRS of $6,000.

Want to hear more about the benefits of bankruptcy for debt consolidation and debt reduction?

Feel free to call us to speak with our bankruptcy lawyers Los Angeles.