Overall, it’s been a bad year for debt settlement companies, as attorneys general from Illinois to West Virginia have become serious about combating abusive practices within the debt settlement industry. A few months back, the New York State Attorney General’s Office announced that the state has secured subpoenas against 14 national debt settlement companies. At the same time, the Consumer Credit and Debt Protection Act was introduced in the U.S. House of Representatives. If passed, the Act would provide the Federal Trade Commission with the authority to create a commission specifically to govern the industry.
Why has all this attention been focused on the debt settlement business? Well, outstanding credit card debt is a major problem in our country — revolving credit now stands at $ 928.0 billion, and that figure is mostly comprised of credit card charges. Unfortunately, as credit card lenders enact new fees and raise interest rates, consumers are becoming hard pressed to find solutions to relieve the increasing pressure on their monthly budget. Although the benefits of debt settlement are debatable, at best, it should come as no surprise, then, that many consumers choose this option when they feel they have nowhere else to turn. As you know, desperate people don’t always make good choices, and there are plenty of companies out there looking to take advantage of consumers when they’re most vulnerable. That’s why more and more states are taking a hard look at the debt settlement business these days.
The growth of the debt settlement industry is also due to advertising campaigns that guarantee amazing results. You’ve probably seen ads that promise to save 50, 60, or even 75% on your overall debt, all while improving your credit. Interestingly enough, it is these types of exaggerated claims that may lead to the downfall of debt settlement. Until recently, state regulators didn’t have the time, resources, or commitment to stop these kinds of deceptive ads, and they began to dominate the airwaves. Unfortunately, perception is reality for many people, and the sad reality for many consumers has been that the promises made in many debt settlement ads have been too good to resist.
A basic problem inherent in debt settlement is the approach used to secure the settlement itself. Debt-settlement companies evaluate the indebtedness of an individual and establish a monthly payment amount based on their findings. These monthly payments are made directly to the debt settlement company and are retained in an escrow account. Contrary to many clients’ understanding, these funds are not immediately sent to creditors. This actually makes sense, because many creditors would be unwilling to settle a debt unless they were confident there were funds available to satisfy the payoff amount. However, while the settlement firm accumulates cash, creditors go unpaid. Meanwhile, interest and late fees accrue, your debt increases, and collection calls continue. Even more alarming is your exposure to lawsuits brought by your unpaid creditors. New York Attorney General Cuomo has advised that, “Enrollment in a debt settlement plan premised on stopping payments to creditors will likely lead to more frequent and aggressive creditor collection efforts, often resulting in judgments, wage garnishments, and the freezing of bank accounts.”
Although the ads may claim otherwise, the debt settlement process can have a devastating effect on your credit score. According to a representative at Fair Isaac Corp., the organization that developed the FICO credit scoring system, consumers in debt settlement plans often see their credit scores plummet. Why? Your payment history accounts for 35% of your score. If the debt settlement company withholds payment for several months while they build up a lump sum in hope that the creditor will give in, your score will suffer the consequences month after month. What’s worse, settling a debt for less than the amount owed results in a seriously negative mark on your credit score, a notation that will remain visible to other lenders for seven years.
The practice that made settlement firms appear on the radar of state regulators had to do with the fees they charge. Debt settlement companies often charge an up-front fee of 10% to 15% of the total amount owed. They may also charge monthly fees of about $50, and a back-end fee of 20% to 30% of the amount “saved” for clients in a settlement. Your initial fee alone for these services might be several thousand dollars, and, in the unlikely event that such a service helped you settle your debt, you could stand to pay tens of thousands more in fees and tax penalties. I say “unlikely” because the industry has a success rate of roughly 2%.
If you’re having difficulties paying your credit cards or other unsecured debt, the first call should be to your creditor to see if you can work out a repayment plan with them. If you’re unsuccessful, your very next call should be to an accredited credit counseling service to examine the full range of options appropriate to your specific situation.
For more information, or to speak with a certified credit counselor please contact Cambridge Credit Counseling at 800-897-2200 or www.cambridgecredit.org.