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Considering Debt Settlement? Is That A Dangerous Idea?

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At the end of 2015, U.S. consumers' credit card debt had grown to over 900 billion dollars. Average household credit card debt is over $7,500. If you are struggling to manage debt, then ads like these may be tempting:

  • Eliminate 50 -70% of your debt legally. It's your right!
  • Pay off your debt for pennies on the dollar.
  • New government programs! Take advantage of free and easy programs for those in debt right now.
  • Stop harassing calls from debt collectors!

What's the problem with such "offers"? They are misleading and deceptive at best. At worst, they are fraudulent, abusive, unfair, and some are illegal. Signing up for them could leave you in worse shape financially than before. This report gives you the facts behind the claims of debt settlement companies and profiles better options for resolving debt problems.

What Are Debt Settlement Programs?

Debt settlement companies are for-profit companies that, for a fee (or fees), try to negotiate lump sum settlements of unsecured debts for lower amounts than the full balances you owe. To "qualify" most companies want you to have at least $10,000 in debt, but that amount varies widely.

After you sign up with a company, you are asked to save a certain amount monthly in a special account or your own account. When you've accumulated a predetermined sum, and only then, the company will begin to try to negotiate settlements with your creditors. As of October 2010, it is illegal for debt settlement companies to collect any upfront fees. A fee can only be collected once each debt has been renegotiated or otherwise resolved. Before you sign up for their services, companies must now provide you the following:

  • Explain their fees and any conditions on the services.
  • How many months or years it will be before they will make an offer to each creditor.
  • How much money or the percentage of each outstanding debt you must save before they will make an offer to a creditor.

Most companies also advise you to quit paying your credit card accounts, even those you may be current on. The reason, they say, is that creditors won't negotiate settlements until the accounts are in default. Many companies imply that not paying these accounts will hurt your credit rating only a little, less than bankruptcy, because you are in their debt settlement program. However, according to a report by the General Accountability Office, the FICO company (which developed the most frequently used credit scoring program) indicates that your credit score will take a big hit and that being in a debt settlement program has no effect on how your credit is rated. Companies must now tell you about the possible negative consequences of not paying your credit card accounts, such as damage to your credit report and score, creditors may sue or continue with the collection process, and that your credit card companies may charge you additional fees and interest. There is also no guarantee that the company will be able to negotiate a reduced settlement. Even though the 2010 Telemarketing Sales Rule amendment prohibits debt settlement companies from making false or unsubstantiated claims, there are still a number of misleading claims being made, that we examine below.

How Does Debt Settlement Differ From Other Debt Counseling or Debt Management Options?

Reputable, nonprofit credit counseling services help consumers look at their complete financial picture. They typically help clients develop a budget and, often, help them create a debt management plan. In such debt management plans, the credit counseling organization typically works with a consumer's creditors to develop a payment plan that has lower payments that are easier for the consumer to manage, but the total amount of balances owed is not reduced. Reputable nonprofit counseling organizations may charge a modest fee for helping with debt management plans.

Debt consolidation loans, another option, are used to pay off full balances of credit card and other debt; the consumer then makes just one payment for the new loan rather than multiple payments. In appropriate circumstances a consolidation loan from a reputable lender, such as your credit union, may result in paying less interest overall and sometimes may result in a lower payment. The term (length) of the loan and its interest rate (APR) are factors in whether a consolidation loan achieves these goals.

What Are the Facts About Common Debt Settlement Claims?

Advertisements for debt settlement services on the Internet, in the mail, and via phone use a variety of claims to prompt consumers to check out their services. Here are the facts behind some of the most common claims.

Claim: Guaranteed success in reducing debt.

Fact: Success rates are actually very low. According to the Federal Trade Commission (FTC), there is no guarantee that a debt settlement company can persuade a credit card company to accept partial payment of a debt you legitimately owe. Investigations by several state attorneys general and the FTC found that most enrollees fail to complete debt settlement programs. In Colorado, for example, less than 10% of enrollees completed the program.

Success to the debt settlement company may not be success to the consumer, either. In just one New York example, a widow who completed her program ended up paying out thousands more than she originally owed. Because she finished the program, the company counted her as a "success."

Claim: Debt can be reduced 50 to 70 percent. Some companies claim more modest figures, such as only 24 to 40 percent.

Fact: Debt reductions, when the company succeeds, are typically much smaller. In a lawsuit against debt settlement companies, the New York State Attorney General's office found that only 0.3% (three tenths of one percent) of clients received the promised debt reduction of 25% to 40%. Although industry-reported data indicate higher figures, it's important to note that these data are voluntarily self-reported and may use different measurements. The Association of Settlement Companies (TASC), a trade group, in a survey of larger member companies reported that 34.4% of enrollees completed their program and settled at least 75% of their debt. Even if there were no problems and inconsistencies in the survey methodology, these figures (25% reduction for a third of clients) are still a long way from the 50-70% reduction in debt and 85-100% success rates so often claimed.

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Claim: You have a legal right to debt reduction or "debt relief."

Fact: Credit card companies and other creditors are not legally obligated to accept offers for less than the full outstanding balance of accounts. Although some states have laws and regulations related to debt settlement, these laws affect the practices of debt settlement companies not creditors or consumers. In addition, neither the federal Fair Credit Reporting Act (FCRA) or the Credit Card Act of 2009 address or include issues of debt settlement.

Claim: A debt settlement plan is government sponsored, government "authorized," or government "approved." Some companies use advertising headlines such as "New Government Programs! New free and easy programs are available for those who are in debt right now!" or "Obama Credit Card Bailout" or "Credit Card Debt Relief Bill." Website domain names may imply government sponsorship of programs by containing such phrases in their URLs as "creditreliefact," "bailout" or "GovernmentDebtRelief," for example.

Fact: Debt settlement plans are NOT part of any government programs whatsoever. When asked, marketers often explain that this claim means simply "the government allows us to do this." Others may imply that because banks received government TARP bailout money that the government is pressing banks to do something for consumers. These claims are totally false, according to the FTC, the GAO, and other government agencies.

Claim: Enrolling in a debt settlement plan will stop calls or other action by creditors or collection agencies.

Fact: Collection efforts will continue and may even increase. Although a debt settlement company may send cease-and-desist letters to creditors or indicate that an individual has entered a debt settlement program, these are largely ineffective. Collection calls may actually increase. If individuals cease paying accounts, creditors may turn the account over to collection agencies; they may also sue the account holder.

Claim: If we can't get you out of debt in 24 hours, we'll pay you $100. Other less extreme claims promise to have consumers debt-free in 12, 24 or 36 months.

Fact: Claims are misleading. The majority of plan participants drop out before finishing. When the GAO asked one company to explain the 24 hour promise, the representative said that if the client had a large lump sum available they could do that but "ninety-nine point nine percent of the people that come to us to not have the ability to do that." At another company, the representative say that "24 hours" was a "typo;" the headline ought to have said 24 months.

Claim: Debt settlement companies are government regulated. One representative told the GAO investigator that their company was "licensed and regulated" by the TASC, which is "like the SEC."

Fact: Debt settlement companies are not federally regulated. Some states have laws about debt settlement practices. The Association of Settlement Companies (TASC) is a nonprofit trade group and lobbyist as is the United States Organizations for Bankruptcy Alternatives (USOBA). Although these trade groups set standards for practice and consumer protection, member companies do not necessarily follow those standards. In the GAO investigation, for example, a majority of the 20 companies examined belonged to one or the other trade organization and all but one were judged to have used misleading, abusive or fraudulent practices.

Other Potential Problems with Debt Settlement

In addition to deceptive claims promises, debt settlement practices pose other difficulties for consumers.

  • It's hard to know who you are dealing with. Many websites are marketers for one or more affiliates. In its investigation, even the GAO had difficulty tracing the webs of connections.
  • Many companies post "consumer education" websites or articles that appear to warn consumers away from deceptive or abusive debt settlement practices; in fact, these are actually veiled solicitations for business. We found one misleading article that was designed to look as if it came from the FTC but was fake; it appeared in one of those web-based article databases to which anyone may contribute.

Other Options for Managing Debt

Contact your creditors yourself. The FTC and other experts suggest that consumers keep lines of communication open with creditors. By calling your credit card companies directly you may be able to negotiate better terms. Settling Credit Card Debt from the FTC gives you some tips.

Consider credit counseling. Talking with a reputable, nonprofit credit counseling organization can help you develop a plan to manage your money, bills, and debts. Talk first to your credit union about services they may provide or a credit counselor they recommend. Whatever your situation, at BayPort we have the resources available to meet your needs. It is much easier to avoid getting into financial trouble than to dig out from under it. Workshops and other tools and resources are also available through the Bayport web site.

For More Information

Dealing with Debt from the Federal Trade Commission (FTC) has numerous articles on managing debt, credit repair, debt relief, and debt collection that will help you understand your rights under the Fair Debt Collection Practices Act and help you recognize debt-related scams and fraud.

Debt Relief Services & the Telemarketing Sales Rule: A Guide for Business from the FTC. Though this is written as a guide for businesses, it is helpful for consumers as well because it explains what information a business must provide to them.

In late 2010, the FTC amended the Telemarketing Sales Rule to add specific provisions to curb deceptive and abusive practices associated with debt relief services. The following report shows why the provisions are needed.

Debt Settlement: Fraudulent, Abusive, and Deceptive Practices Pose Risk to Consumers, April 2010, report from the Government Accountability Office. Although this report is more than 40 pages, it's full of eye-popping information and specific examples. You can also listen to a podcast interview with one of the investigators.


Reviewed and updated May 2016.

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