How Debt Reduction Companies Generate Revenue

Debt reduction companies help you refinance, settle, consolidate or modify the debt obligations you have with another lender. Some of these companies may be very ethical, and others may be looking to take advantage of desperate borrowers. Even if you work with a non-profit debt reduction company, however, you will still find that the agents have to charge a fee to cover their costs. The way they charge this fee can help you understand the caliber of company you are working with.

Up Front Fees, Membership Fees

The FDIC warns borrowers against any debt reduction strategy that requires an up-front fee. These fees may be called "membership fees." They are advertised as a way to join a debt reduction group, and they promise a host of services in return. However, most of these services will still cost an additional fee. The company may start issuing charges you were not intending on paying when you first signed up, even if the company has not rendered a single service in your direction. Avoid up-front fees or membership fees, as they are not legitimate charges for services.

Recovery-Based Fee

One fee structure used by more ethical groups is a recovery-based fee. In this option, the company will get paid only if it helps you reduce your debt. For example, you may want to settle a $20,000 auto loan for $15,000. The reduction expert will negotiate this in exchange for a three percent fee. This means the agent will receive three percent of the $5,000 saved, or $150. If the company succeeds in reducing your debt only by $3,000, you only pay $90. There is no fee structure that is "appropriate" or "too high." It is important to keep in mind, though, that whatever you pay the reduction company comes out of your ultimate savings. It makes sense to aim for only a few percentage points' charge.

Flat Fee

A flat fee option may not be as favorable as a recovery-based fee, but this depends on the sum you are hoping to eliminate. If you would like to settle over $100,000 of debt for $70,000, for example, you could end up paying a service $900 using the above model. If the company offers to carry out the negotiations for a flat fee of $500, you may benefit. Larger settlements can be less expensive with flat fees. However, the agency may not be successful in reaching your desired sum, and you could still be on the hook for the whole payment.

Undisclosed Fees

In some cases, a debt reduction company will attempt to tack on additional fees at the end of your service. These undisclosed fees may be illegal according to regulations set by the Consumer Protection Agency. This is particularly true if your debt reduction company is also offering you a loan to pay the sums you owe. Then, the reduction company is acting as a lender, and lenders are subject to a host of rules and regulations beyond those set for traditional financial consulting companies.

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