3494: What is Debt Settlement and How Does It Work? by James Lambridis of Debt MD on Debt Settlement Explained

What It Covers

James Lambridis of DebtMD explains how debt settlement works, outlines five critical risk questions to evaluate before enrolling, identifies red flags of scam companies, and recommends nonprofit credit counseling as a safer alternative.

Key Questions Answered

• •Pre-enrollment checklist: Before signing with any debt settlement company, answer five specific questions: tax consequences of forgiven debt, ability to sustain monthly payments for 36-plus months, whether all debts can be settled, credit score impact, and all fees charged by the company.
• •Tax liability risk: When a creditor forgives a portion of debt, the IRS may classify that forgiven amount as taxable income on federal returns. Consult a tax accountant or attorney before enrolling to calculate potential tax exposure from any settlement arrangement.
• •Scam red flags: Avoid any debt settlement company that guarantees specific reduction percentages like 30–60%, claims to stop all collection calls, promotes a government debt elimination program, or charges fees before resolving debts — the last practice is prohibited under the FTC's Telemarketing Sales Rule.
• •Nonprofit alternative: The National Foundation for Credit Counseling offers certified nonprofit counselors who negotiate debt management plans, build affordable budgets, and work with creditors without requiring borrowers to go delinquent — avoiding the credit damage and lawsuit risk tied to for-profit settlement companies.