Consumers who struggle with debt may consider turning to a debt settlement firm, but this strategy can backfire in several ways.
First, it can damage a credit score. Debt settlement companies usually insist that consumers stop paying their bills for a few months, after which the company contacts the creditors and tries to negotiate settlements on the consumer's behalf. However, failure to pay can stain a credit report and damage FICO credit scores; and even when creditors agree to accept less than the full amount owed, they will report to credit bureaus that the account was “Settled” or “Paid by Settlement,” which still tarnishes credit records.
The second way this tactic can hurt consumers is by risk of lawsuit or court judgment. Instead of reaching an agreement with a debt settlement company, creditors may decide to sue the borrower, get a judgment against him or her, or have wages garnished.
A third reason to avoid debt settlement is that many debt settlement firms also charge high fees, either in the form of a flat fee or a percentage of the total debt.
A fourth drawback is that consumers must pay taxes on the amount of money they saved. Better alternatives to debt settlement include trying to negotiate directly with creditors, or consulting a credit counseling firm.