When credit card balances outgrow your paycheck, ads promising "one low payment" start to look tempting. Two very different services sit behind those ads. Credit counseling with a debt management plan works to make your payments affordable. Debt settlement tries to get creditors to accept less than you owe. Here is how each works, how each can affect your credit and which red flags to watch for.
Flex Fuel does not promise deletions, score increases or approvals. This article is general education, not legal, tax or financial advice. The right path depends on your debts, income and goals.
Credit counseling and debt management plans
The Consumer Financial Protection Bureau explains that credit counseling organizations are usually nonprofits whose counselors help with budgets, money and debt questions and, when it fits, a debt management plan.
How a debt management plan works
Under a debt management plan, you make one payment to the credit counseling organization each month or pay period, and the organization pays each of your creditors. According to the CFPB, a plan typically lowers your monthly payments and can lower interest charges and fees. Counselors may get creditors to lengthen the time you have to repay or reduce your interest rate.
A few points the CFPB makes clear:
- A plan does not erase debt. You still repay what you owe, usually on easier terms.
- Counselors do not always negotiate the balance down. The goal is a lower overall monthly payment.
- Fees are allowed. Most organizations are nonprofits, but they can charge for some services. Get a specific price quote in writing.
- A reputable counselor never tells you to stop paying your debts.
- The arrangement usually does not affect your taxes.
The CFPB also warns that some organizations offering debt management plans have defrauded people. Before you send money, contact your creditors and confirm they have accepted the proposed plan.
Debt settlement (debt relief) companies
The CFPB describes debt settlement or debt relief companies as businesses, usually for-profit, that say they can renegotiate, settle or change the terms of your debt. They typically pay creditors lump sums you save up first.
Why debt settlement is risky
The CFPB lists several risks:
- These companies often charge expensive fees.
- They typically encourage you to stop paying your credit card bills. Late fees, penalty interest and other charges then pile up, and collection efforts usually step up.
- Some creditors refuse to work with these companies, and many debts never get settled.
- A creditor may file a debt collection lawsuit while you are saving up.
- Built-up penalties on unsettled debts can wipe out the savings on the debts that do settle.
The CFPB's bottom line is blunt: debt settlement "may well leave you deeper in debt than you were when you started."
Forgiven debt can be taxable
If a creditor forgives part of what you owe, the IRS explains in Topic 431, Canceled Debt that the canceled amount is generally taxable, with certain exceptions. The creditor may send Form 1099-C. Talk with a tax professional before you settle so the tax bill does not surprise you.
How each option can affect your credit
Your credit reports reflect how accounts are actually paid, and that is the biggest difference here.
Debt settlement: The CFPB says using debt settlement services can hurt your credit scores and your ability to get credit in the future. The usual strategy of stopping payments while you save means missed payments can be reported each month. Learn how those marks work in our guides to late payments and charge-offs.
Debt management plan: Because you keep making payments, you avoid the damage of deliberately missing them. Plans work differently from creditor to creditor, though. Ask the counselor and each creditor how your accounts will be handled and reported while you are on the plan, including whether any cards will be closed. Closing cards can change your credit utilization.
Either way, check your credit reports before you start and as you go. Flex Fuel clients use SmartCredit to see their credit reports and scores in one place and track changes month to month.
Weighing a debt management plan against debt settlement? Book a time to look at your credit reports and debt payoff options with us.
Your rights against upfront fees
Under the FTC's Telemarketing Sales Rule (16 CFR 310.4), a company selling debt relief services by phone generally cannot request or receive a fee until three things happen:
- It has renegotiated, settled, reduced or otherwise changed the terms of at least one of your debts under an agreement you signed.
- You have made at least one payment under that agreement to the creditor or debt collector.
- Fees for debts settled one at a time stay within the rule's limits.
The CFPB adds that money you save in a dedicated account for a settlement company still belongs to you. The account must be run by an independent third party and stay under your control, and you can withdraw your money at any time without penalty.
Red flags to walk away from
The CFPB says to avoid any company that:
- Charges any fees before it settles your debts
- Promises it can settle all your debt for a set percentage reduction
- Touts a "new government program" to bail out credit card debt
- Guarantees it can make your debt go away
- Tells you to stop communicating with your creditors
- Claims it can stop all collection calls and lawsuits
- Guarantees your unsecured debts can be paid off for pennies on the dollar
Other options to compare
Credit counseling and settlement are not the only roads. Depending on your situation, you might:
- Call your creditors directly. Ask about hardship programs, lower rates or payment plans. The CFPB notes settlement companies usually cannot get better terms than you could by negotiating yourself.
- Pick a payoff method. The debt snowball vs. avalanche approaches work without any new credit.
- Compare consolidation. See our consolidation loan vs. balance transfer breakdown.
- Talk to a bankruptcy attorney. The CFPB lists this option if you cannot afford what you owe. Our guide to rebuilding credit after bankruptcy covers what comes next.
Already dealing with collectors? See our guide to collections on your credit report.
How Flex Fuel helps
Flex Fuel works with clients nationwide (we are based in Atlanta) to review all three credit reports, check that each account is reported accurately and build a realistic plan for paying down debt and rebuilding. We are not a debt settlement company, we do not tell clients to stop paying their bills, and we only take actions you authorize. Explore our services and see how our guarantee works.
Feeling buried in credit card debt? Book a complimentary strategy session. We will review your credit reports with you and map out your next steps.
Book a Consultation ›Frequently asked questions
Is credit counseling the same as debt settlement?
No. The CFPB explains that credit counselors are usually nonprofits that help with budgets and debt management plans to lower your monthly payment. Debt settlement companies are usually for-profit and try to get creditors to accept less than you owe, often after you stop paying.
Does debt settlement hurt your credit?
The CFPB says debt settlement services can have a negative impact on your credit scores and your ability to get credit in the future, especially because companies usually advise you to stop paying while you save.
Can a debt settlement company charge fees upfront?
Under the FTC's Telemarketing Sales Rule, companies selling debt relief by phone generally cannot collect fees until they have settled or changed at least one debt and you have made at least one payment under that agreement.
Is forgiven debt taxed?
Often. The IRS says canceled debt is generally taxable unless an exception applies, and the creditor may send Form 1099-C. Ask a tax professional about your situation.
