Consumers urged to be cautious of debt settlers


April 10, 2005|By EILEEN AMBROSE

NOW THAT regulators and legislators are taking steps to protect consumers from unscrupulous credit counselors, there's growing concern about the burgeoning debt-settlement industry.

These companies, virtually all for-profit, differ from the nonprofit credit-counseling agencies that enroll debtors in repayment plans. Instead, debt settlers try to negotiate a reduction in the amount of debt owed to a creditor, usually a credit-card company.

A negotiator might ask a card company to accept 40 cents for every dollar owed, which is probably more than the card issuer would get if the debtor filed for bankruptcy.

For years, lawyers and credit counselors have done debt settlements for cash-strapped clients on the brink of bankruptcy, experts said. Debt settlement as an industry, though, is about five years old, with an estimated 300 companies nationwide, according to the United States Organizations for Bankruptcy Alternatives, an eight-month-old trade association with more than 50 debt settler members.

Regulators and consumer advocates warn that the practices of some of these companies can leave consumers deeper in debt, harassed by bill collectors and with a worse credit record.

The Federal Trade Commission announced this month a settlement with three groups - two of which were involved in debt negotiation - that were accused of bilking consumers of more than $100 million. The FTC said that few consumers' debts were settled and that in some cases they were sued by creditors and forced to file for bankruptcy.

States also are examining the companies. Nine states are looking at whether the companies fall under existing laws or whether new legislation is needed to regulate them, said Kallie Guimond, executive director of the industry association.

In Maryland, debt negotiation companies don't fall under legislation passed two years ago to regulate nonprofit credit counselors.

The state Department of Financial Regulation has been studying debt settlement companies in recent months to determine whether legislation is needed to regulate the groups or prohibit them, said Joseph E. Rooney, deputy commissioner.

Business models for debt negotiations can vary, but they often work like this: Consumers give a debt settler power of attorney to negotiate on their behalf. Debtors then contribute money each month into an account, building up cash that will be offered to a creditor as a settlement. Fees are extracted from the account.

A company might charge an upfront fee of $500 and a monthly maintenance fee, said Jennifer Larabee, an FTC lawyer in Los Angeles who has worked on cases against debt negotiators. If a settlement is reached, the company also might charge a percentage of the amount of forgiven debt. In some cases, it's 25 percent, Larabee said.

In some instances, she said, "they advise consumers to do something that is never a good idea, which is stopping paying your debt and communicating with your creditors." The theory is that if a consumer gets further in arrears, a credit-card company might be more willing to settle, she said.

But consumers often aren't warned of the consequences, Larabee said. Once they stop paying bills, late fees kick in and interest builds. As debt grows, some consumers' balances top their credit limits and they are charged an additional fee, Larabee said, adding, "It snowballs."

Sometimes consumers had been making on-time minimum payments but sought the help of a debt settler because card balances were high, Larabee said. Once they stopped making payments, they damaged their credit records, she said.

Consumers often aren't aware that the credit-card company can sue them and, depending on state law, might be able to garnish wages and place a lien on their house, Larabee said.

Many consumers drop out of debt settlement programs. "They couldn't handle the collection calls and ended up forced into bankruptcy," Larabee said.

According to the FTC's case against National Consumer Council, a defunct California nonprofit that solicited clients for debt settlers, 638 out of 44,844 consumers completed the debt settlement program.

Even if a negotiator reaches a settlement, it's possible that once all the fees are factored in, a debtor might pay more to the debt settler than he initially owed the credit-card companies, Larabee said.

Some suggest that consumers who have savings can negotiate their debts on their own.

"There is nothing wrong with trying to get a creditor to negotiate with you," said Deanne Loonin, a staff attorney with the National Consumer Law Center.

"I don't see any benefit to going through one of these companies."

If debtors need help negotiating, they should seek the help of a reputable lawyer or credit counselor, Loonin said. Sometimes, she said, bankruptcy is the best solution for those in deep financial trouble.

Guimond, of the trade association, acknowledged that there have been abuses.

"The FTC shows they won't have any tolerance for that," she said.

She said her organization is developing standards for its members and supports legislation to keep the bad actors out.

But the industry shouldn't be shut down, she said, noting that debt settlement provides a service for insolvent consumers who don't have enough income to pay off their debt through a repayment plan offered by credit counselors.

Also, Guimond said, the debt settlers often negotiate with creditors for less than a lawyer would charge.

The debate is sure to add to consumers' confusion over where to seek help.

"There is so much money in consumer debt that everyone is clawing their way to get a piece of it," said Eric Friedman, chief of Montgomery County's consumer affairs division. "You have so many different players and so many different labels that consumers are left trying to sort out the good from the bad from the ugly."

To suggest a topic, contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose

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