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Beware of Debt Reduction / Counseling Offers



You have most likely received offers from “debt counselors” at one time or another promising to consolidate your debt, reduce your interest rates or negotiate settlements with your creditors. BEWARE. While there are reputable credit counseling organizations that do have your best interests in mind, most of the offers you get will likely come from someone more concerned about profiting from your situation.
Let’s look at a recent case we had where one of our clients hired a “debt reduction” agency prior to coming to us to represent them. The chart below is a reproduction of the actual plan summary given to our client that details the plan for reducing the client’s debt. The names of our client and the agency have been removed in the interest of privacy.

Estimated Settlement
Plan Cost

Payment Schedule

Estimated Personal Savings Plan
for Payment to Creditors

51,997.23 Total
Service Fee:
7,799.58 Estimated
Settlement Amount
(Approx. 40%)
(Approx. 40%):
20,798.89 3 Initial
Payments of:
595.80 Savings Budge
During Initial
Service Fee:
7,799.58 Initial
Payment Total:
1,787.40 Minimum Savings
During 21 Remaining
Service Fee Payments:
Total Debt
Elimination Cost:
28,598.47 Remaining
Service Fee
6,012.18 Minimum Personal
Saving Payments
After Agency Fee
is Paid:
Total Debt Savings: 23,398.76 21 Monthly Service
Fee Payments of:
286.29 Total Payments
toward Savings
After All Payments:
Monthly Budget
595.80 Total Months
to Payoff
Service Fee:
24 Estimated
Time Frame:
48 Months

Now let’s analyze the numbers.

  • The Client has total unsecured debt of almost $52,000, and the Agency estimates it can settle this debt for 40% of the total.
  • For its “work,” the Agency charges the Client a fee of almost $8,000, 15% of the total debt.
  • The first thing the Agency does is to tell the Client to stop making any payments toward their credit cards for 2 YEARS. Think that’s good for your credit? The Agency then contacts the credit card companies and tells them to close the accounts.
  • The Plan provides for the Client to make 24 monthly payments of $595.80. The first 3 payments go directly to the Agency. After that, the Agency is paid $286.29 per month for 21 months, while the Client is told to set aside the remaining $309.51 in a “savings” account. This money does NOT go toward paying off the Client’s debt for the entire 2 year period.
  • After 2 years, the Client will have put aside $7,428.24 (309.51 x 24 months) in the separate account. The Agency will use this amount to negotiate with the Client’s creditors. The Agency will contact the credit card companies offering to settle the debt for 40%. They will use the Client’s savings as leverage to make the deal knowing that the credit card companies are willing to settle for less if they are paid money up front.
  • After 2 years, the Client will have paid the Agency $7,799.58, more than it has put in the account to pay the creditors. Almost $8,000 for what? The Agency does almost NOTHING for 2 years other than to create the “savings” schedule and close your credit card accounts. When the 2 years is finally up, the Agency makes a few more calls to settle the debt. In the meantime, you continue receiving bills and telephone calls from creditors for the next 2 years harassing you to pay your debts.
  • Why 2 years? Because the Agency knows that if you don’t make payments for 2 years, the credit cards companies will consider the debt almost uncollectible, and they’ll be happy to get whatever they can.
  • Assuming they are able to settle your debt for 40% of the total, the down payment you’ve saved is only equal to 14%. This means that you will have to enter into a payment plan, probably over another 2 years, to pay the remaining 26% (40% – 14%).
  • And what if you aren’t able to meet the payment schedule the Agency negotiates for you? Depending on the terms of the settlement, the credit card company may reinstate the entire amount of the original debt, and you’re back to step 1. It is very important to understand that most debt reduction plans fail because debtors can’t afford the monthly payments negotiated by their debt counseling agencies.


Now more bad news. When a creditor “forgives” a debt that you owe, the amount of the debt that is forgiven is considered income to you on which, with some exceptions, you must pay taxes. That’s right. You must pay taxes on money you never receive. This is referred to as “income from the discharge of indebtedness,” and it may actually be more difficult for you to handle than the original credit card debt. Why? Keep reading.
When you owe money to credit card companies, it is rare that they will file a lawsuit against you to collect. They will badger you constantly, but it is rare for them to actually pursue collection action in court. The IRS is not so lenient. When you owe tax to the IRS, you will eventually get a Notice of Deficiency from them telling you how much tax you owe. If you ignore the Notice of Deficiency, eventually the IRS will place a lien against your property. If you ignore the liens, the final step will be a levy, where the IRS can seize your property and garnish your wages.

Let’s use the numbers from the chart above to see what would happen to the Client. The chart shows that the debt savings to the Client will be $23,398.76. After agreeing to settle the debt with the Client after 2 years, the credit card company will send the Client Form 1099 showing income to the Client of $23,298.76. Assuming the Client is in the 25% tax bracket, the Client will have to pay an additional $5,824.69 in taxes. And if the Client can’t pay the tax? Don’t bother telling the IRS. The Client will likely have to enter into a 5 year repayment plan on top of the plan he or she already entered into with the credit card company.

So after taxes, what was the real debt elimination cost?

Settlement Amount $20,798.99

Agency Service Fee $7,799.58

Tax $5,824.69

Total $34,423.26.


The RESULT: the Agency only saves the person 34% of its total debt (not the 60% savings it would have you believe), the Client must spend 2 years ignoring collection calls, another 2 – 3 years paying the remaining debt agreed to in the settlement, possibly 5 years paying the tax due on the debt forgiveness, and on top of everything else, the Client’s credit is still ruined.


If you aren’t capable of repaying all of your debt, but you either don’t want to file for Chapter 7 bankruptcy or don’t qualify, Chapter 13 provides a much cheaper, more reliable repayment-plan alternative. You can think of Chapter 13 bankruptcy as court-supervised debt consolidation and reduction, and your creditors will be required to go along with the plan.

The following are some of the benefits Chapter 13 bankruptcy presents that typical debt reduction plans don’t:

  • A court-approved and supervised debt reduction plan with which creditors must comply;
  • An immediate and automatic stop to all collection action by creditors;
  • Relief from the anxiety that is caused from avoiding creditors for 2 or more years;
  • The opportunity to propose a repayment plan to the court that the debtor can actually afford; and
  • NO TAX DUE for debts discharged in bankruptcy.
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