You’ve heard the fast-talking ads on the radio and seen the spots on TV and the Web: Companies promise to cut your credit-card debt in half, with no damage to your credit rating. Say you’ve racked up $30,000 in damage on your plastic. The ads say you’ll end up paying out $15,000 over five years or even less.
Sound too good to be true? You’re right. What the debt-settlement companies don’t tell you is that it may take them months to negotiate a payment with your first creditor. Why? Because you typically have to build up enough cash in an equity account to pay off the debt in a lump sum. That’s easy if you’ve run up $200 on a card, but a lot harder when you owe $5,000.
Making matters worse, before you can accumulate the money needed to pay off that card, the debt-settlement company’s fees — anywhere from 15% to 50% — are typically deducted up front.
State attorneys general such as New York’s Andrew Cuomo have been investigating this practice and prosecuting companies that take clients to the cleaners instead of paying off their cards.
In May 2009, Cuomo sent subpoenas to 14 debt-settlement companies, including Debtamerica Relief, Freedom Debt Relief and New Era Debt Solutions. The investigation is still pending, even though Cuomo is heading to the Governor’s office, according to a spokesman in the Attorney General’s office.
One reason why state prosecutors have gone after debt-settlement companies is they have been virtually free of federal oversight — until now.
Over the past two months, the Federal Trade Commission has been phasing in rules that govern how debt-management outfits market their services. Now, the firms will be banned from collecting an advance fee for their services. Instead, they will have to wait until a partial settlement is made before taking their cut.
A trade association for the industry has promised to support the new rules, even though industry surveys indicate that between 50% and 80% of debt-settlement companies will close down now that the new regs are in effect.
“We recognize that the Federal Trade Commission attempted to strike an appropriate balance between improving consumer protection and ensuring continued viability for the majority of ethical, well-managed debt-settlement companies,” said Robby H. Birnbaum, president of the Association of Settlement Companies.
Ahead of the new FTC rules, the trade group adopted new marketing guidelines for its members, including prohibiting the use of government seals and symbols as well as terms such as “bailout” that could give potential clients the impression that the debt settlement program is sanctioned by Uncle Sam.
Many firms, such as San Mateo, Calif.-based Freedom Debt Relief, have used the Internet to cross state lines and get clients. FDR claims to have served more than 57,000 people nationwide, and saved them $171 million.
In addition to being probed by New York state, Freedom Debt Relief was sued by the government in its home state of California. The 18-month-long civil lawsuit was settled in January with no findings of wrongdoing and without any admission of liability.
Still, the fact remains that only 30 percent of debt-settlement companies’ customers nationwide ever reach a settlement with their creditors, according to industry figures.
Many consumers drop out of programs when they realize they are accruing late and over-the-limit fees during the many months before a payment to their creditor is made by their debt settlement company.
The new FTC rules are designed to help consumers get their money’s worth and put the industry’s less reputable players out of business.