A recent New York Times article exposed the grave pitfalls consumers are facing, lured by debt consolidation companies that advertise aggressively. The pitch is simple: “Don’t file bankruptcy. Instead, pay money to the debt negotiation company, which negotiates lower payments or lump sum settlements.” The problem is that it is never so easy. The debt settlement industry is raking in money. The New York Times observes that the industry is “So lucrative, that an industry trade association, the United States Organizations for Bankruptcy Alternatives, recently convened [in Palm Springs, Florida], in the oceanfront confines of the Four Seasons Resort, to forge deals and plot strategy.” However, after the debt consolidation company takes its cut of the consumer’s money, the consumer is rarely in a better position, and often has to file bankruptcy anyway.

These companies go by many names, including debt consolidation, debt negotiation, and debt elimination companies. The most common tactic these debt consolidation companies is to instruct the consumer to allow their bills to go into default. Instead of paying the creditors, the consumer is told to pay the money to the the debt settlement company. The debt negotiation company takes a percentage of the money paid in – often as high as 15% to 20%. Then the debt settlement company contacts the creditors and attempts to negotiate a lower payment, or a settlement that is for a small percentage of the full debt.

In the past, it may have been possible to construct such a house of cards. But creditors have become savvy, and more aggressive. If the creditor waits until the debt negotiator has settled with the other creditors, then there may be a larger pot of available funds, and the debt settlement company may have to agree to a higher amount to get the last settling creditor into the house of cards. Or, the creditor may not settle at all, causing the house of cards to collapse entirely. By this time, the consumer is in default on all of their bills, has paid exorbitant fees to the debt elimination company, and is still deep in debt. They are looking at filing for bankruptcy after all.

By contrast, bankruptcy can be a line drawn in the sand. The consumer pays a fee for a qualified bankruptcy attorney to file their bankruptcy petition and schedules. By law, all of the creditors must immediately stop all collection efforts, including calls, letters, and lawsuits. Foreclosures are halted. Garnishments stop. The bankruptcy court judge decides which of the debts are dischargeable, and what money and property the debtor is entitled to keep. After the judge issues a discharge order, the discharged debts are gone forever.

Although the bankruptcy is a significant impact on a consumer’s credit report, all of the impact is felt at one time. The bankruptcy judgment will be off of the consumer’s credit report within ten years. After about two years of paying bills on time, a consumer will typically qualify for credit on regular terms. By contrast, using the debt consolidators and debt settlement companies may result in lawsuits and collections for years down the road.

As the New York Times reports, there really is no question about the value of the services of these companies. It is a bad deal for consumers. Bankruptcy is a serious decision with long lasting consequences. But it marks a definite line in the sand from which a consumer can discharge most or all of their debts, start over from scratch, and get a fresh start.

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