Hardly a day that goes by that I do not speak to a new client who says that they hired a debt settlement company to take care of their credit card debts but none of the debts were settled despite making all their payments and now they are being sued and garnished by the credit card companies.

Under a debt settlement program a person is told to stop paying their credit cards and to send the settlement company a monthly payment that will go into a “settlement fund.” In general, credit card companies will settle their accounts for about 40% of the outstanding balance depending on the age of the account and the likelihood of collecting the full balance. So, the idea here is to save up about 40% of what you owe by skipping the regular credit card payment and diverting the money to a debt settlement savings account. In addition, the debt settlement company usually charges a 15% “settlement fee” plus other “account maintenance fees”, so you really need to save up 55% to 60% of the account balances.

 Does this work? Almost never. The problem is that most folks can’t save 40% of what they owe fast enough before they get sued for not paying the account. Most banks will turn the account over for litigation after six to twelve months of no payments. If you stop paying your creditors you will get sued, it is just a matter of when. Debt settlement is a race to save enough money to settle before the creditor sues. And this is why debt settlement companies almost never deliver on their promises because virtually all your money goes to pay their fees before any money is deposited into the settlement fund.

SmartMoney reporter Aleksandra Todorova writes in a July 9, 2010 column that “many creditors, once they know a client is working with a debt-settlement company, will escalate the account, meaning that they send it to a collection agency sooner or sue you.”

As a general rule, if you don’t have at least one-third of what you owe in a settlement fund within six to nine months, the program will never work. And this is why over 90% of debt settlement programs are doomed from day one.

Oh, did I mention that if you settle your debts for less than what you owe this can be taxable income reported to the IRS? Yeah, if you are lucky enough to settle a debt the credit card company will probably send the IRS a 1099-C Form (Cancellation of Debt Form). Depending on your situation, the forgiven debt may be taxable.

If you want to settle your debts do yourself a favor and don’t hire a settlement company. Hire yourself, but only do this if you can save enough cash in 6 to 9 months to have at a bare minimum of one-third of what you owe in a separate bank account. If you want to hire someone to help settle, hire a licensed attorney in your community.