You can handle debt issues better than agencies

updated 7:40 a.m. ET Nov. 6, 2009

NEW YORK - Reduce your debt by 60 percent! Stop collection calls! Be debt free in 12 months!

The siren song of debt settlement firms is getting harder to ignore these days, especially if your finances are out of control or creditors are knocking at the door.

Tempting as their ads may be, however, debt settlement firms can leave you in an even worse mess. Many are outright scams.

"If a company's making big promises, it should raise red flags," said Alison Southwick of the Better Business Bureau. "Getting out of debt is not easy. It takes time."

Still, it's no surprise that people are vulnerable to promises of relief. It's probably why complaints against debt settlement firms rose by almost 19 percent in 2008 over the previous year, according to the BBB.

Before you pick up the phone, here's what you need to know.

How it works
The premise behind debt settlement firms is that they'll negotiate with lenders, usually credit card companies, to whittle down your balance. You pay the negotiated amount in a lump sum. Some firms promise to lower your debt by as much as 70 percent.

The incentive for lenders is that they salvage at least part of what they're owed.

Prices vary, but a firm might charge up to 20 percent of however much you owe. So the fee for a $10,000 loan might be $2,000. Fees are usually demanded upfront before a settlement is delivered.

Apart from the fact that a settlement may never be secured, the offer is riddled with traps. But more on that later.

You should know that the BBB automatically lists all debt settlement firms under its new "inherent problem" category, meaning it has concerns about the entire industry.

Companies can apply to be removed from the category by demonstrating they deliver on their advertising claims. No firms have been removed yet, although some are in the application process.

Better alternatives
The bottom line is that there's no need to hire anyone. You can negotiate a settlement directly with your lender.

"They have a complete picture of your finances. They will know if you're a candidate," said Gail Cunningham of the National Foundation of Credit Counseling, a nonprofit group based in Silver Spring, Md.

Before you even reach that point, however, be sure to exhaust all other options. A negotiated settlement comes with serious consequences and should be a last resort.

If you feel overwhelmed, ask for a free consultation at a nonprofit credit counseling agency. You may be able to develop a budget that lets you meet your debt payments if you work with a counselor.

You can search for a local agency on the Web sites of the National Foundation for Credit Counseling (www.nfcc.org) or the Association of Independent Consumer Credit Counseling Agencies (www.aiccca.org).

MORE FROM PERSONAL FINANCE

Personal finance Section Front

Answer Desk: Adding up bank bailout losses   Americans getting better at managing credit Therapy tries to achieve life, account balance FDIC: Minorities struggle to access banks Vanguard: 60 percent of 401(k) have recovered Answer Desk: Repairing consumer credit  New $100B safety net for jobless in works Congress scrambles to extend estate tax Auto loan delinquency rate edges higher Jobless face expiration of health benefit Personal finance Section Front   Add Personal finance headlines to your news reader: