New Rules Could Erase Debt Settlement Industry

Unless you’ve been living in a cave for the last several years, you’ve seen and heard debt settlement ads – the ones that make is appear that eliminating credit card debt is as simple as paying “pennies on the dollar.”

But after October of this year, those ads may start fading away, along with many of the companies. Yesterday the Federal Trade Commission announced what could become crippling restrictions on this particular way to deal with consumer debt.

We’ve done several articles on the problems surrounding debt settlement – the process of offering a creditor (typically a credit card company) less that the full amount owed to satisfy a debt. The new FTC restrictions are designed to address consumer complaints regarding companies making promises they didn’t keep and charging high up-front fees for services they ultimately didn’t provide.

New rules taking affect in October of 2010 will prohibit a common debt settlement practice – charging an upfront fee prior to fully eliminating a customer’s debt. The new rules also require disclosure of how long the settlement process could take, what it costs and the potential damage than can result to a consumer’s credit history. (See Should I Consider Debt Settlement?) The rules, which will apply only to for-profit debt settlement companies, also require that the companies set up dedicated accounts for payments they collect and hold for consumers.

In a press release announcing the new regulations, Jon Leibowitz, chairman of the F.T.C., said “Too many of these companies pick the last dollar out of consumers’ pocket and, far from leaving them better off, push them deeper into debt, even bankruptcy,”

“This rule will stop companies who offer consumers false promises of reducing credit card debts by half or more in exchange for large, upfront fees,” he said.

Debt settlement has been a burgeoning business as the recession, unemployment and the housing bust combined to result in millions of Americans with monthly debt payments they couldn’t meet. These companies offer a seemingly simple and attractive solution by advertising that they can settle debts for a fraction of what’s owed.

The process of debt settlement often requires a consumer to set aside money in an account for many months – even years – until enough is collected to offer a credit card company a lump-sum settlement. Since after October many debt settlement companies won’t be able to collect any fees until the end of the process, that could put many out of business.

But don’t expect all the internet ads you see regarding debt settlement to go away. The new rules cover calls made from consumers in response to debt settlement ads, as well as telemarketing calls. The rules don’t apply, however, to transactions that take place face-to-face or entirely online.

The new rules cover calls consumers make to debt settlement firms in response to advertising as well as telemarketing calls made by firms. However, the FTC’s new regulation does not apply to in-person sales or to Internet-only sales.

Because consumers can often confuse legitimate credit counseling organizations with unsavory debt settlement companies, my advice – after October, at least – is to weed out debt settlement companies by getting on the phone with any company offering to help you reduce your debt burden. And to always ask about up-front fees.

In addition to the FTC crackdown, two bills are also pending in Congress (Senate Bill 3264 and House Bill 5387) that would radically limit the fees companies can charge. Current fee structures are commonly 10% of the amount of debt negotiated – the new legislation would limit them to a maximum one-time fee of $50 plus five percent of the settlement savings.