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While other businesses struggle to stay afloat, the debt-settlement industry is flourishing.

For many cash-strapped consumers, debt settlement may seem like the only option -- short of declaring bankruptcy. In such cases, the consumer hires a debt-settlement company to negotiate a one-time payment -- usually totaling about 40% to 60% of their total debt -- that will be paid to their creditor. The creditor then forgives the remaining debt. While this tactic is perfectly legal, it can cost consumers dearly and, in many cases, leave them even deeper in debt.

Here are sine things you need to know before hiring a debt settlement company.

You'll pay a hefty price

Debt-settlement companies charge fees that often run into the thousands of dollars. Payment structures vary. Some companies charge 13% to 20% of the consumer's total debt, which gets paid over the first 12 to 15 months. Other companies charge up to 35% of a projected settlement amount. For someone with $50,000 in debt that's as much as $10,000 in fees that need to be paid before the consumer can start paying off the settlement itself.

Expect the process to be contentious

Most banks strongly oppose working with debt-settlement companies. The reason? Debt-settlement companies instruct clients to stop paying their bills in order to save for a future settlement. (The savings are deposited in a special account, from which the debt-settlement company withdraws its monthly fee.)

Attrition rates are astoundingly high

If you decide to go the debt-settlement route, the odds are stacked against you. While debt-settlement companies don't release their completion rates, a look into the records of one organization -- the National Consumer Council, which the Federal Trade Commission sued for misleading advertising and shut down in 2004 -- paints a grim picture. Of the company's 44,844 clients, only 638 (a meager 1.4%) successfully completed the debt-settlement program. Nearly half (43%) canceled after paying an average $1,780 in fees.

You could get sued

Since debt-settlement companies instruct consumers to stop paying their bills while they're saving for a settlement, their balances continue to swell with interest and late fees and their credit scores plummet. In order to get paid, creditors may even sue -- and these days, companies do that some time in the second year of nonpayment, says Phelan. With most debt-settlement plans taking 36 months or longer to complete, the chances of getting sued are pretty high.

By Aleksandra Todorova
Source: SmartMoney/
Click here to read the entire article

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