Under new regulations adopted by the Federal Trade Commission, for-profit debt settlement companies will no longer be allowed to collect fees for their services until they have settled some or all of a consumer’s debt. The rules are effective Oct. 27.
The new regulations will help curb deceptive and abusive practices in debt relief services sold through telemarketing, according to Consumers Union, the nonprofit publisher of Consumer Reports.
“Most debt settlement companies charge big fees up front even though most consumers don’t get the help they expect,” said Lauren Bowne, Staff Attorney for Consumers Union’s Defend Your Dollars campaign (www.DefendYourDollars.org)
“These new rules will help protect consumers who are already drowning in debt from being ripped off by debt settlement companies that fail to provide any relief. But more needs to be done to ensure that the amount of fees charged for debt settlement services are fair.”
Most debt settlement companies market their services through internet, television, or radio advertising.
The advertisements typically promise to substantially reduce debt and urge consumers to call a toll-free number to find out more. Once the consumer signs up, the debt settlement company takes its fees over the first half of the contract period.
The FTC reports that nearly two-thirds of consumers who enroll in debt relief services, most of which pay an advance fee, end up dropping out of the programs within the first three years without getting the help they paid to receive.
Debt settlement companies usually advise consumers to stop paying their creditors and to instead set up a special account to build savings that will be used in the future to negotiate a settlement.
As the consumer deposits savings into the account, the debt settlement company withdraws money to cover its fees even though it hasn’t reached a settlement with creditors. By stopping payments to creditors, the consumer ends up with a worse credit score, additional penalty fees and more interest charges.
While debt settlement companies claim they settle millions of dollars in debt for consumers, they have not revealed how much debt remains unsettled.
The Better Business Bureau announced that it would stop calling debt settlement services “inherently problematic” if a company could show that it met several conditions, key among them that at least one half of its customers saved as much money as was paid in fees. The GAO reported in April 2010 that two debt settlement trade associations called that standard “unrealistic.”
The FTC’s new regulation banning advance fees will go into effect on October 27, 2010 and takes a key step forward by addressing the timing of the fees. Under the new rules, a debt settlement company will earn fees when it reaches a settlement on at least one of the consumer’s debts that the consumer agrees to in writing. Fees cannot be collected until the consumer has made at least one payment to the creditor as a result of the negotiated agreement.
Fees can be held in a dedicated account before that time but all unearned fees must be returned to the consumer if he or she decides that the debt settlement program is not working out or cancels the program.
Debt settlement firms can only require a dedicated account under certain conditions, including that the account must be set up and maintained by the consumer at an insured financial institution. The consumer will be entitled to earn interest on the account and can withdraw the funds at any time without penalty.
Beginning on September 27, 2010, the FTC rule requires that debt settlement companies make certain pre-contract disclosures, including how long it will take to get results and how much it will cost.
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, so Congress or the states will have to act to apply the new rules to those debt settlement contracts.
“The FTC regulations will ensure that debt settlement companies will only get paid if they help consumers but it doesn’t stop them from charging outrageously high fees,” said Bowne. “Now it’s up to state lawmakers or Congress to cap debt settlement fees to a reasonable percentage of the actual savings for consumers.”
Two federal bills (S. 3264 and HR 5387) have been introduced in Congress to limit debt settlement fees to a one-time $50 fee and five percent of the savings from each final settlement.
