When bills, debts, or loans become difficult to pay, debt settlement may seem like a practical solution. You may see ads claiming that a company can reduce your debt, lower your payments, or help you avoid bankruptcy. You may also find attorneys who offer debt negotiation services.

Both debt settlement companies and attorneys may try to persuade creditors to accept less than the full amount you owe. The question is, which should you choose? Here is a comprehensive guide that can help you decide which assistance to seek, depending on your financial situation:

How Debt Settlement Works

Debt settlement happens when a creditor agrees to accept less than the total amount owed.

For example, suppose you owe $15,000 on a credit card. The creditor may agree to accept $8,000 as full settlement of the account. Hence, you pay the agreed amount, and then the creditor forgives the remaining balance.

Debt settlement is different from debt consolidation. With consolidation, you take out a new loan to pay several debts and then repay the new loan. It is also different from a debt management plan, which usually focuses on reducing interest rates and creating a structured repayment schedule.

Most debt settlement companies ask you to stop paying your creditors and deposit money into a separate account. Once enough money has accumulated, the company then begins making settlement offers.

This strategy carries risks. While you are saving money, creditors may continue adding interest and late fees. Your credit may suffer, and a creditor may sue you before a settlement is reached. Creditors are not required to work with a settlement company or accept less than the full balance.

How Arizona Regulates Debt Management Companies

Arizona regulates certain companies that receive money from consumers and distribute it to creditors: 

1. Under Arizona Revised Statutes § 6-701, a debt management company generally includes a business that receives money from an Arizona resident and distributes it to creditors as payment of debts.
2. Companies covered by this law usually must be licensed by the Arizona Department of Insurance and Financial Institutions under A.R.S. § 6-703. Thus, before hiring a company, ask whether it is licensed in Arizona or claims an exemption. You should verify the answer through the Arizona Department of Insurance and Financial Institutions rather than relying only on the company’s salesperson.
3. Licensed debt management companies must also review whether a consumer can reasonably afford the proposed plan. Under A.R.S. § 6-710, a company should not enroll you unless a written budget analysis shows that you can make the required payments.
4. A.R.S. § 6-709 also limits certain fees charged by licensed debt management companies. However, the rules may apply differently depending on how the company structures its services. Some companies only negotiate debts while a separate bank or payment processor holds your money.

What a Debt Settlement Company Can Do for You

To manage your accounts, a debt settlement company can review your debts, estimate how much you may need to save, and contact creditors with settlement offers.

For example, suppose you owe $30,000 across several credit cards. The company may ask you to deposit $500 each month into a dedicated account. When enough money has accumulated, it may offer one creditor a lump-sum settlement.

The company cannot force a creditor to accept the offer. One creditor may agree, another may demand more money, and another may file a lawsuit.

You should ask what happens if you are sued. Some companies say they offer legal support, but that may only mean they refer you to another provider. Ask whether an Arizona attorney will represent you, if that includes court appearances, and whether you must pay additional fees.

Federal law also limits advance fees for many debt relief companies that sell services by telephone. Under the Federal Trade Commission’s Telemarketing Sales Rule, a covered company generally cannot collect a settlement fee until:

• It has successfully changed the terms of at least one debt
• You have accepted the settlement
• You have made a payment under the agreement

How a Debt Settlement Attorney Can Help You

While negotiating debt settlements, a debt settlement attorney can also examine whether the debt is valid and whether the creditor can prove its claim.

For example, a debt buyer may sue you for an old credit card account. An attorney can review the following:

• If the debt buyer owns the account
• The accuracy of the balance 
• Whether the lawsuit was filed within the applicable time limit

A debt settlement company usually focuses on how much you can offer. An attorney can determine whether you have a legal defense and whether you should pay the debt at all.

With legal representation, you can also respond to lawsuits, file court documents, negotiate during litigation, and appear at hearings. If you ignore a lawsuit, the creditor may have a chance to obtain a default judgment, depending on your circumstances. That judgment may lead to wage garnishment, bank account garnishment, or other collection efforts, subject to Arizona and federal exemptions.

An attorney can also compare debt settlement with bankruptcy. If you owe more than you can realistically settle, bankruptcy may provide a more complete solution.

Risks of Stopping Payments

Many settlement programs depend on you stopping payments. This may encourage creditors to negotiate, but it also creates serious risks.

For instance, suppose you owe $25,000 on four credit cards and stop paying all of them. During the next several months, interest and late fees increase the balances. Your credit reports show missed payments and charge-offs. One creditor settles, but another files a lawsuit.

Any savings from the settlement must be compared with company fees, added interest, court costs, tax consequences, and the remaining unsettled debts.

Hiring an attorney does not remove these risks if the strategy also requires you to stop paying. However, an attorney should explain the legal consequences and prepare for possible lawsuits.

When a Debt Settlement Company May Be Reasonable

A reputable debt settlement company may be appropriate when:

• You have unsecured debts 
• The balances are accurate
• No lawsuits are pending
• You can afford to save enough money for settlement offers

For example, you may have two collection accounts and enough savings to make lump-sum offers. You may not need full legal representation if the company is properly licensed, explains its fees, and gives you control over your settlement funds.

Still, you should compare the company’s fee with the cost of negotiating directly. Creditors may offer similar settlements without a third-party company.

When You Should Consider an Attorney

You should consider a debt settlement attorney when:

• You have received a summons or complaint.
• A judgment has been entered against you.
• There is a risk of bank account or wage garnishment.
• The debt amount is disputable.
• You believe the debt resulted from identity theft.
• A debt buyer cannot prove ownership.
• The debt is secured by a car or home.
• Settlement payments are too expensive. 
• Bankruptcy may be an option.

An attorney may cost more, but the services are usually broader. If the fee agreement includes negotiation, lawsuit defense, court appearances, garnishment issues, and bankruptcy advice, it may be well worth it. 

Watch for Warning Signs

Avoid any company that guarantees it can reduce every debt by a specific percentage. No provider can force a creditor to settle.

Be cautious when a company:

• Demands large advance fees.
• Pressures you to sign immediately.
• Tells you to ignore court papers.
• Claims a secret government program will erase your debt.
• Gives vague answers about legal representation.
• Promises to stop every lawsuit or collection effort.

Arizona’s Consumer Fraud Act, A.R.S. § 44-1522, prohibits deceptive practices, false promises, and the concealment of important facts in connection with the sale of services.

Which Option Is Better?

A debt settlement company may be enough when your debts are straightforward, no lawsuit has been filed, and you have money available for settlements.

On the other hand, an attorney is usually the better choice when legal rights are at risk. This includes lawsuits, judgments, garnishments, disputed debts, secured loans, large balances, and possible bankruptcy.

Therefore, before signing a contract or stopping payments, compare the expected savings, professional fees, added interest, tax consequences, and the likelihood that you can complete the process. In the end, the best option is the one that protects your legal rights and gives you a realistic path out of debt.