June 8, 2010
The ads are ubiquitous, and for consumers awash in debt, nearly impossible to ignore: Reduce your credit card bills 50%! Avoid bankruptcy! The relief is real!
Behind the ads is a fast-growing industry that barely existed a decade ago. Debt-settlement companies claim they can significantly reduce borrowers' debts by negotiating directly with creditors. Unlike most businesses, these companies have flourished during the economic downturn.
But a growing group of lawmakers, regulators and consumer advocates say these companies exploit desperate borrowers, often leaving them deeper in debt. The Federal Trade Commission wants to restrict fees the companies charge. Sen. Charles Schumer, D-N.Y., has introduced legislation that would bar debt-settlement companies from collecting fees until a settlement has been reached. Last month, Oregon's attorney general reached a settlement with Credit Solutions of America, the USA's largest debt-settlement firm, that bars the company from operating in that state for three years.
Now, the industry is fighting back.
The Consumer Credit Rights Campaign, a coalition of debt-settlement companies, says the proposals would eliminate a legitimate option for consumers who can't afford to fully repay debts and don't want to file for bankruptcy.
Debt-settlement companies act as a valuable intermediary between borrowers and lenders, says Don Goldberg, a Campaign spokesman. "If you take them away, you're leaving consumers on their own."
Criticisms of the debt-settlement industry include:
Upfront fees reduce the amount available to pay off creditors
When a borrower signs up for debt settlement, the company typically will tell the individual to make monthly payments to a savings account. After a certain amount of money has been saved, the debt-settlement company will go to the borrower's creditors and offer to use the money to pay off a percentage of the debt.
But the amount available to pay creditors is often reduced by the debt-settlement company's fees. An investigation by the Government Accountability Office of 20 debt-settlement companies found several instances in which up to four months of monthly payments were kept by the debt-settlement company before any money was put aside to settle debts.
The Federal Trade Commission has proposed prohibiting debt-settlement companies from charging any fees until they've provided services to their customers. The industry doesn't oppose capping fees, but banning them outright would put most legitimate debt-settlement companies out of business, says John Ansbach, legislative chairman for the United States Organizations for Bankruptcy Alternatives, a trade group.
In some cases, it takes debt-settlement companies two or three years to negotiate a settlement, Goldberg says. "They're not trial lawyers, where they have a huge payoff," he says. "They can't fund their business without having a revenue stream."
Debt-settlement companies often tell consumers to stop paying their bills, which leads to late fees, higher interest rates and lawsuits
Amy Arensdorf, 42, of York, N.Y., contacted Credit Solutions of America in 2007 after a divorce left her with large credit card debts.
The company representative told her to stop paying her credit card bills and assured her that creditors wouldn't take any action against her for at least two years. But three weeks after she signed up for the program, Arensdorf found a summons on her door from one of her creditors, threatening to take her to court if she didn't pay her bill. Then she started receiving collection calls at work.
When she contacted Credit Solutions, she says she was told to stop answering the phone.
Arensdorf eventually dropped out of the program and borrowed money from her parents to pay some of her debts. She says the program ruined her credit and left her worse off than when she started.
"I have nothing," she says. "This wiped me out. It's the biggest nightmare I ever had."
In a statement, Credit Solutions said it secured multiple settlements for Arensdorf and offered to refund 50% of her fees after she complained to the Better Business Bureau.
"The image of the industry, and specifically of our company, as depicted by much of the media, is totally at odds with the consumer benefit we provide," the company said.
Credit counselors often end up trying to help consumers whose credit has been ruined by debt-settlement companies, says William Binzel, chief counsel for the National Foundation for Credit Counseling, a trade association for credit counselors.
"By the time they come to us, many have default judgments against them, some have had their wages garnished, and they're literally out thousands of dollars," he says. "Unfortunately, for a lot of those, their only alternative is bankruptcy."
The Association of Settlement Companies (TASC), a trade group, says its standards prohibit members from telling customers to stop paying their bills. However, 17 of the 20 debt-settlement companies contacted by GAO employees posing as potential customers encouraged them to stop making payments. Five of those companies, the GAO says, were members of TASC.
Goldberg says the GAO investigation was too narrow to represent industrywide practices. The agency used 20 phone calls "to try and tar an entire industry," he says.
Consumers can negotiate debt settlements on their own
In 2007, Linda Coons, 48, of Richardson, Texas, contacted Precept Financial Solutions after her credit card issuer increased her minimum monthly payments. She was current on her accounts but feared she would have trouble affording the higher payments.
She was told to stop paying bills and to put $500 a month into an account. Coons says she was also told that her $64,000 in debts would be eliminated in 36 months.
After a few months, though, the amount Coons owed ballooned, and the interest rate on one of her cards rose to 30%. While she paid Precept $6,900 in fees, she ended up negotiating settlements with most of her creditors herself, she says.
"They (Precept) weren't helpful in paying things off," Coons says. "They weren't calling creditors. I should never have done this."
Precept didn't respond to a request for comment.
Representatives for the banking industry say consumers who talk to their lenders early on may be able to negotiate partial payments, interest-only payments or other types of relief. Lenders "much prefer that people first start with them and not go to debt settlement," says Nessa Feddis, senior counsel for the American Bankers Association.
American Express doesn't work with for-profit companies that focus exclusively on debt settlement, spokeswoman Marina Hoffmann Norville says. "We believe there is no service or benefit that a for-profit debt-settlement company can offer our card members that they could not receive from working directly with us."
Satisfied debt-settlement customers say they tried working with their lenders and got nowhere.
Faith Zabriskie, 55 of Bedford, Texas, ran up big credit card debts after a 2007 bathroom fall left her unable to work for several months. As her balances rose, her interest rates soared. Efforts to negotiate with the creditors were fruitless, Zabriskie says. One bank told her it wouldn't help her until she was at least six months behind on her payments, she says.
Zabriskie ended up contacting DebtXS, a debt-settlement company based in Frisco, Texas. She was instructed to put $500 a month into a savings account for three years. Debt XS used that money to settle Zabriskie's debts for about 50% of what she owed. Zabriskie says she's now almost debt-free and is working on rebuilding her credit score. "I feel like they saved my life," she says.
Settlement vs. counseling
Many consumer advocates and the Better Business Bureau say consumers who are struggling with debt should consult a non-profit credit-counseling agency before considering debt settlement. These agencies help consumers set up a payment plan, and also provide financial education programs.
Credit-counseling agencies' primary tool is the debt-management plan, or DMP. Consumers who enroll in these programs agree to make monthly payments to a credit-counseling agency, and the agency uses the money to pay their bills. Creditors may agree to lower interest rates, waive penalty fees and stop collection activities while the debt is being repaid.
Consumers pay only a small fee to enroll in credit counseling, and non-profit agencies will waive fees for low-income consumers. Yet, part of their funding comes from creditors that participate in DMPs, which means they have an inherent conflict of interest, Goldberg says. "They're paid by the banks," he says. "Their goal is to keep you from dropping out of payment programs. They're not advocates for you."
Critics also charge that credit counseling doesn't help people with unmanageable debts because the principal amount owed isn't reduced. Credit-counseling representatives acknowledge that the dropout rate for the plans is high. The National Foundation for Credit Counseling says 55% of clients who sign up for a DMP complete the program.
But there's a critical difference between a consumer who drops out of a credit-counseling DMP and one who fails to complete a debt-settlement program, Binzel says. Consumers who discontinue a debt-management plan are no worse off than they were when they started, and many are better off because they've paid at least some of their debts, he says. By contrast, he says, debt-settlement dropouts usually find themselves even deeper in the hole because fees, interest and penalties have inflated the size of their debts.
The success rate for debt settlement is elusive. The Association of Settlement Companies says a 2009 survey of its largest member companies found that 34% of customers settled at least 75% of debts enrolled in their programs. That's considerably lower than claims made by some of the companies contacted by the GAO. Representatives claimed success rates for their programs of 85% to 100%.
Even the trade group's conservative success rate is much higher than those uncovered by federal and state regulators in investigations of debt-settlement companies. A survey by Colorado's attorney general found that from 2006 to 2008, less than 10% of Colorado consumers successfully completed their debt-settlement programs. An investigation by the New York attorney general into an Arizona-based debt-settlement company found that only 0.3% of clients realized the promised savings.
An alternative plan
While lenders advise consumers to avoid debt settlement, some eventually agree to negotiate with debt-settlement companies, says Robert Manning, a former director of the Center for Consumer Financial Services at the Rochester Institute of Technology. "There wouldn't be any debt-settlement industry if the banks didn't accept the offers," he says. The Association of Settlement Companies says its members settled more than $1 billion in debts last year.
Manning has founded a non-profit organization, the Responsible Debt Relief Institute, and is working with the credit-counseling industry on an alternative to debt settlement for consumers who can't afford to pay 100% of what they owe. He has developed an algorithm that calculates the amount of debt a consumer can afford to repay, based on the individual's household finances. Credit counselors can use that figure to work out a plan that allows consumers to pay off the reduced amount over 36 months.
The AAA Fair Credit Foundation, a non-profit credit-counseling agency based in Salt Lake City, launched a pilot of Manning's program in February. The program fills an important need, says Chief Executive Preston Cochrane. Up to three-quarters of consumers who come to AAA Fair Credit can't afford to repay all their debts, making them ineligible for a traditional debt-management plan, he says.
Without a partial-payment alternative, the credit-counseling business faces extinction, because the number of borrowers who can't afford a traditional DMP is growing, Manning says.
That leaves borrowers who don't want to file bankruptcy with few choices, he says. "It's a system that's set up for debt-settlement companies and their lawyers to make money."
The ads are ubiquitous, and for consumers awash in debt, nearly impossible to ignore: Reduce your credit card bills 50%! Avoid bankruptcy! The relief is real!
Behind the ads is a fast-growing industry that barely existed a decade ago. Debt-settlement companies claim they can significantly reduce borrowers' debts by negotiating directly with creditors. Unlike most businesses, these companies have flourished during the economic downturn.
But a growing group of lawmakers, regulators and consumer advocates say these companies exploit desperate borrowers, often leaving them deeper in debt. The Federal Trade Commission wants to restrict fees the companies charge. Sen. Charles Schumer, D-N.Y., has introduced legislation that would bar debt-settlement companies from collecting fees until a settlement has been reached. Last month, Oregon's attorney general reached a settlement with Credit Solutions of America, the USA's largest debt-settlement firm, that bars the company from operating in that state for three years.
Now, the industry is fighting back.
The Consumer Credit Rights Campaign, a coalition of debt-settlement companies, says the proposals would eliminate a legitimate option for consumers who can't afford to fully repay debts and don't want to file for bankruptcy.
Debt-settlement companies act as a valuable intermediary between borrowers and lenders, says Don Goldberg, a Campaign spokesman. "If you take them away, you're leaving consumers on their own."
Criticisms of the debt-settlement industry include:
Upfront fees reduce the amount available to pay off creditors
When a borrower signs up for debt settlement, the company typically will tell the individual to make monthly payments to a savings account. After a certain amount of money has been saved, the debt-settlement company will go to the borrower's creditors and offer to use the money to pay off a percentage of the debt.
But the amount available to pay creditors is often reduced by the debt-settlement company's fees. An investigation by the Government Accountability Office of 20 debt-settlement companies found several instances in which up to four months of monthly payments were kept by the debt-settlement company before any money was put aside to settle debts.
The Federal Trade Commission has proposed prohibiting debt-settlement companies from charging any fees until they've provided services to their customers. The industry doesn't oppose capping fees, but banning them outright would put most legitimate debt-settlement companies out of business, says John Ansbach, legislative chairman for the United States Organizations for Bankruptcy Alternatives, a trade group.
In some cases, it takes debt-settlement companies two or three years to negotiate a settlement, Goldberg says. "They're not trial lawyers, where they have a huge payoff," he says. "They can't fund their business without having a revenue stream."
Debt-settlement companies often tell consumers to stop paying their bills, which leads to late fees, higher interest rates and lawsuits
Amy Arensdorf, 42, of York, N.Y., contacted Credit Solutions of America in 2007 after a divorce left her with large credit card debts.
The company representative told her to stop paying her credit card bills and assured her that creditors wouldn't take any action against her for at least two years. But three weeks after she signed up for the program, Arensdorf found a summons on her door from one of her creditors, threatening to take her to court if she didn't pay her bill. Then she started receiving collection calls at work.
When she contacted Credit Solutions, she says she was told to stop answering the phone.
Arensdorf eventually dropped out of the program and borrowed money from her parents to pay some of her debts. She says the program ruined her credit and left her worse off than when she started.
"I have nothing," she says. "This wiped me out. It's the biggest nightmare I ever had."
In a statement, Credit Solutions said it secured multiple settlements for Arensdorf and offered to refund 50% of her fees after she complained to the Better Business Bureau.
"The image of the industry, and specifically of our company, as depicted by much of the media, is totally at odds with the consumer benefit we provide," the company said.
Credit counselors often end up trying to help consumers whose credit has been ruined by debt-settlement companies, says William Binzel, chief counsel for the National Foundation for Credit Counseling, a trade association for credit counselors.
"By the time they come to us, many have default judgments against them, some have had their wages garnished, and they're literally out thousands of dollars," he says. "Unfortunately, for a lot of those, their only alternative is bankruptcy."
The Association of Settlement Companies (TASC), a trade group, says its standards prohibit members from telling customers to stop paying their bills. However, 17 of the 20 debt-settlement companies contacted by GAO employees posing as potential customers encouraged them to stop making payments. Five of those companies, the GAO says, were members of TASC.
Goldberg says the GAO investigation was too narrow to represent industrywide practices. The agency used 20 phone calls "to try and tar an entire industry," he says.
Consumers can negotiate debt settlements on their own
In 2007, Linda Coons, 48, of Richardson, Texas, contacted Precept Financial Solutions after her credit card issuer increased her minimum monthly payments. She was current on her accounts but feared she would have trouble affording the higher payments.
She was told to stop paying bills and to put $500 a month into an account. Coons says she was also told that her $64,000 in debts would be eliminated in 36 months.
After a few months, though, the amount Coons owed ballooned, and the interest rate on one of her cards rose to 30%. While she paid Precept $6,900 in fees, she ended up negotiating settlements with most of her creditors herself, she says.
"They (Precept) weren't helpful in paying things off," Coons says. "They weren't calling creditors. I should never have done this."
Precept didn't respond to a request for comment.
Representatives for the banking industry say consumers who talk to their lenders early on may be able to negotiate partial payments, interest-only payments or other types of relief. Lenders "much prefer that people first start with them and not go to debt settlement," says Nessa Feddis, senior counsel for the American Bankers Association.
American Express doesn't work with for-profit companies that focus exclusively on debt settlement, spokeswoman Marina Hoffmann Norville says. "We believe there is no service or benefit that a for-profit debt-settlement company can offer our card members that they could not receive from working directly with us."
Satisfied debt-settlement customers say they tried working with their lenders and got nowhere.
Faith Zabriskie, 55 of Bedford, Texas, ran up big credit card debts after a 2007 bathroom fall left her unable to work for several months. As her balances rose, her interest rates soared. Efforts to negotiate with the creditors were fruitless, Zabriskie says. One bank told her it wouldn't help her until she was at least six months behind on her payments, she says.
Zabriskie ended up contacting DebtXS, a debt-settlement company based in Frisco, Texas. She was instructed to put $500 a month into a savings account for three years. Debt XS used that money to settle Zabriskie's debts for about 50% of what she owed. Zabriskie says she's now almost debt-free and is working on rebuilding her credit score. "I feel like they saved my life," she says.
Settlement vs. counseling
Many consumer advocates and the Better Business Bureau say consumers who are struggling with debt should consult a non-profit credit-counseling agency before considering debt settlement. These agencies help consumers set up a payment plan, and also provide financial education programs.
Credit-counseling agencies' primary tool is the debt-management plan, or DMP. Consumers who enroll in these programs agree to make monthly payments to a credit-counseling agency, and the agency uses the money to pay their bills. Creditors may agree to lower interest rates, waive penalty fees and stop collection activities while the debt is being repaid.
Consumers pay only a small fee to enroll in credit counseling, and non-profit agencies will waive fees for low-income consumers. Yet, part of their funding comes from creditors that participate in DMPs, which means they have an inherent conflict of interest, Goldberg says. "They're paid by the banks," he says. "Their goal is to keep you from dropping out of payment programs. They're not advocates for you."
Critics also charge that credit counseling doesn't help people with unmanageable debts because the principal amount owed isn't reduced. Credit-counseling representatives acknowledge that the dropout rate for the plans is high. The National Foundation for Credit Counseling says 55% of clients who sign up for a DMP complete the program.
But there's a critical difference between a consumer who drops out of a credit-counseling DMP and one who fails to complete a debt-settlement program, Binzel says. Consumers who discontinue a debt-management plan are no worse off than they were when they started, and many are better off because they've paid at least some of their debts, he says. By contrast, he says, debt-settlement dropouts usually find themselves even deeper in the hole because fees, interest and penalties have inflated the size of their debts.
The success rate for debt settlement is elusive. The Association of Settlement Companies says a 2009 survey of its largest member companies found that 34% of customers settled at least 75% of debts enrolled in their programs. That's considerably lower than claims made by some of the companies contacted by the GAO. Representatives claimed success rates for their programs of 85% to 100%.
Even the trade group's conservative success rate is much higher than those uncovered by federal and state regulators in investigations of debt-settlement companies. A survey by Colorado's attorney general found that from 2006 to 2008, less than 10% of Colorado consumers successfully completed their debt-settlement programs. An investigation by the New York attorney general into an Arizona-based debt-settlement company found that only 0.3% of clients realized the promised savings.
An alternative plan
While lenders advise consumers to avoid debt settlement, some eventually agree to negotiate with debt-settlement companies, says Robert Manning, a former director of the Center for Consumer Financial Services at the Rochester Institute of Technology. "There wouldn't be any debt-settlement industry if the banks didn't accept the offers," he says. The Association of Settlement Companies says its members settled more than $1 billion in debts last year.
Manning has founded a non-profit organization, the Responsible Debt Relief Institute, and is working with the credit-counseling industry on an alternative to debt settlement for consumers who can't afford to pay 100% of what they owe. He has developed an algorithm that calculates the amount of debt a consumer can afford to repay, based on the individual's household finances. Credit counselors can use that figure to work out a plan that allows consumers to pay off the reduced amount over 36 months.
The AAA Fair Credit Foundation, a non-profit credit-counseling agency based in Salt Lake City, launched a pilot of Manning's program in February. The program fills an important need, says Chief Executive Preston Cochrane. Up to three-quarters of consumers who come to AAA Fair Credit can't afford to repay all their debts, making them ineligible for a traditional debt-management plan, he says.
Without a partial-payment alternative, the credit-counseling business faces extinction, because the number of borrowers who can't afford a traditional DMP is growing, Manning says.
That leaves borrowers who don't want to file bankruptcy with few choices, he says. "It's a system that's set up for debt-settlement companies and their lawyers to make money."
Closed November 2010