What to Know About Debt Relief Agencies, Part 1

Debt Settlement This is usually a last resort when you can no longer make payments. The agency negotiates with creditors in an attempt to reduce interest rates and, in some cases, cancel a portion of the debt. Clients typically stop paying creditors directly and instead save money in a dedicated account toward a lump-sum settlement.

Debt Management Plans (DMPs) Nonprofit agencies often focus on debt management plans. They negotiate lower interest rates and fee reductions with creditors, then consolidate unsecured debts (such as credit cards) into one monthly payment made to the agency. The agency then distributes payments to creditors, typically over 3–5 years.

While in a DMP, open credit accounts are usually closed, and you generally cannot open new ones. There are setup and monthly fees for the service. Collection calls typically stop once the plan is active.

Credit Counseling Nonprofit debt relief agencies also offer credit counseling. Certified counselors help people not only manage debt but also improve financial habits through education, budgeting, and personalized plans. They may work with creditors to secure lower payments or interest rates.

The Pros and Cons

The benefits of working with a debt relief agency include:

• One monthly payment instead of multiple payments.
• Potential savings if the agency successfully obtains lower interest rates or cancels a portion of the debt.
• Possibility of getting out of debt faster.
• Debt may be settled for less than what is owed (primarily in settlement programs).
• Reduced direct communication with creditors, which can ease emotional stress.

The downsides include:

• While the agency negotiates (especially in debt settlement), you are often asked to stop making payments to creditors, which can significantly damage your credit score.
• For-profit debt relief agencies (especially settlement companies) charge fees that typically range from 15% to 25% of the enrolled or settled debt.
• Forgiven debt (in settlement programs) is generally considered taxable income by the IRS (unless an exception like insolvency applies).
• You may be required to stop using credit cards.
• With agency fees added in, you could end up paying more overall than the original debt—creditors are not legally obligated to accept reduced settlements.
• Some debt relief agencies are not legitimate; bad actors have been known to prey on people in debt and scam them.

Watch for part two in this series next month, when we’ll discuss whether debt relief agencies are worth using, alternatives to them, and how to choose a reputable agency.