A Review of Traditional Credit Card Debt Settlement Services
The traditional method for dealing with debt most advertised in the media is known as debt settlement, or also called debt negotiation. In the simplest terms, a debt settlement company works with a debtor to help negotiate a settlement with the credit card companies for less than the full amount owed – usually around 50 percent of the original amount. Although this may result in a reduction of monthly payments and an overall lower balance, anyone using this method will still pay back a significant portion of his or her debts.
There are some benefits to this approach for those struggling to make credit card or other unsecured debt payments:
5 Benefits of debt settlement (or credit card debt settlement)
- Avoid bankruptcy: With debt settlements, you can reduce your debt burden and pay off bills at a monthly payment that is usually lower than you are currently paying. The debt settlement company will negotiate with the creditors or collection agency (CA) and offer to settle your debts for as much as you can afford to pay. Thus, you don’t need to file Chapter 7 or Chapter 13 bankruptcy if you can afford to make some sort of monthly payment towards your debts.
- Single payment: Instead of paying multiple bills each month, you’ll have to make a single monthly payment to the settlement company. The monthly payments are accumulated in a trust account in order to be paid to your creditors/CA after negotiation. So, you can avoid the stress of paying debts at different rates and dealing with several creditors at a time.
- Avoid unfair collection practices: You can avoid unfair collection practices and harassment by debt collectors if you negotiate a settlement.
- Eliminate extra charges: The settlement company can try and eliminate late payment fees, if any. Any over-the-limit fees on credit cards can also be minimized or eliminated by way of settlement.
- Get out of debt quicker: In a settlement arrangement, you may be able to get out of debt in three to five years if you keep your payments current.
However, there is a dark side to debt settlement. Many of these negotiated amounts will appear on your credit report as a settled debt rather than paid in full. A settled debt is a black mark on a credit report and will pull your score down for years.
At the time of settlement, if you fail to get a written statement from the creditor that you no longer owe anything on the debt, they may sell the remainder to another collection agency. In addition, any savings are reportable to the Internal Revenue Service (IRS) as forgiven debt, which is considered a form of income. Collection agencies and creditors are required to submit a Form 1099-C to the IRS to report any forgiven debt of $600 or greater. Most debt settlement or debt negotiation companies will fail to inform you of this potential tax liability.
If you seek the aid of a debt settlement company, be very careful because you may have even more problems than you started with. Debt settlement companies charge substantial up-front fees, often charge monthly fees and send nothing to your creditors until you have accumulated enough to settle. At that point, they even take a portion of the forgiven debt as a fee.
Once your debts have accumulated additional interest over time, and factoring in the increased taxes you must pay on forgiven debt, you really are not saving much money at all. Debt settlement companies cannot do anything more than you can do on your own. If you can save money for a settlement and negotiate a settlement amount, then you can settle your own debts without the assistance of a debt settlement company.
If you still think you want to hire a debt settlement company, consider the negative ratings of debt settlement companies as well as the warnings from top regulators against dealing with debt settlement companies:
New York Attorney General Andrew Cuomo‘s office recently advised that ―many consumers would be more successful working directly with their creditors. Debt settlement is sometimes an imperfect option when you handle it yourself, but it rarely is worth it to hire a company that claims to settle your debt for you. The consequences (fees, judgments and ruined credit) are just too severe. The truth is that creditors have no legal obligation to settle. Creditors despise debt settlement companies because they actually reduce the amount of money that they typically receive from debtors that have defaulted on debt.
Traditional Debt Settlement Does Not Work
There used to be about 20 debt settlement companies in the United States. There are now closer to 2,000. They sprang up after the federal law changed in 2005, making it harder to qualify for bankruptcy, and they have proliferated in this down economy. ABC News reported that debt settlement customers are furious that their bills grew while enrolled in a settlement program. Most quit the programs without having a single debt settled. – July 24th, 2009
In the course of their investigation the reporter wrote:
―We visited Credit Solutions of America, the largest debt settlement company in the country. At its Dallas-area headquarters, we saw employees ringing bells and cheering every time they persuaded a credit card company to settle somebody’s debt for less than what they owed. When we visited with our cameras, the noise was deafening. But thousands of unhappy customers have complained about the company.
―(A customer named Karen) Moore signed up, and said that the first thing Credit Solutions told her to do was stop paying her credit card bills, which, according to a study by the National Consumer Law Center, is standard advice in the debt settlement world. Instead, Moore said the company told her to save a chunk of money that could be used to make an offer to the credit card companies to settle her debts once and for all.
But that savings account didn’t accrue fast enough, Moore said, because, in the meantime, Credit Solutions was automatically deducting its own fee — 15 percent of Moore’s total debt — from her account. In the first three months, the company deducted roughly a third of the fee from her bank account and then the ensuing balance over the course of the next 14 months.
Moore remained in the Credit Solutions program for 20 months, and paid the company’s full 15 percent fee, yet Credit Solutions did not initiate a single debt settlement for her. And because she wasn’t paying her credit card bills, the late fees and penalties piled up, causing her debt to soar from $13,000 to $18,000. Meanwhile, her credit score plunged. “I’m out of pocket $2,088,” Moore said. “And nothing to show for it.” She said it’s money she could not afford to lose given that she was in debt in the first place. “Absolutely not. Who can afford to lose money?” she said.
While the ads and sales pitches for debt settlement sound good and give many people who are buried in credit card debt some hope, it is a false hope. While they all tout the ability to reduce debts by 50% or more, reduce your monthly payments and get you out of debt quickly, the reality is far less rosy. The preceding story is not an isolated incident; in fact it reflects the reality of most debt settlement programs.
The Inside Story
The basic strategy these firms employ is to instruct consumers to stop paying creditors once they join the program. Instead, they are told to save money in a separate account that will be used to make a settlement offer at some point in the future. After receiving nothing for many months, the settlement companies say, lenders will be happy to take a lump sum payment for far less than the total debt. Sometimes it works but again the creditors are under no obligation to accept a reduced settlement amount and if they can‘t get payments can seek legal remedies such as lawsuit.
The problem for consumers is that high up-front fees — and additional monthly fees — often mean they have very little to offer creditors after six months or a year in the program.
Big Fees, Small Benefits
Hardy, the former debt settlement worker, said debt settlement companies rack up charges against consumers in numerous ways. For example, he said, while the money saved for eventual debt repayment is held in an outside bank account, there are often fees associated with that. These companies typically charge a monthly service fee of $20 to $40 on these bank accounts for doing absolutely nothing. After all the fees are added up, there’s often very little benefit to the consumer — even if the credit card company agrees to a 50-cents-on-the-dollar offer, he explained. A consumer with $10,000 in debt would eventually pay nearly $4,200 in fees by the time commissions; up-front charges and bank account charges are added in. After paying $5,000 to the creditor, the consumer‘s savings amount to only about $800, he said. And don‘t forget the imputed income tax that the IRS will assess on the $5,000 in debt forgiveness – at a 15% tax bracket that is another $750 reducing the real savings down to only $50!
A typical debt settlement ad promises much but in truth they will deliver very little. Don‘t be fooled by these types of offers – you will only enrich them and will be no better off, or perhaps even worse off, than you were before.
New Regulations for Debt Settlement Companies
Due to the abuses that have been rampant in the debt settlement industry, the Federal Trade Commission has taken action to clamp down on many of the practices we have just discussed by issuing amendments to the Telemarketing Sales Rule. Starting on October 27, 2010, for-profit companies that sell debt relief services over the telephone may no longer charge a fee before they settle or reduce a customer‘s credit card or other unsecured debt.
The Federal Trade Commission announced on July 29, 2010 that the new restrictions are a crack down on the debt settlement industry, which flourished during the economic downturn as borrowers struggled to pay bills. Debt settlement companies will now only be able to charge a fee once a customer’s debt has been reduced, settled or renegotiated. ―At the FTC we strive every day to make sure America‘s middle class families get straight deals for their dollars, Chairman Jon Leibowitz said. ―This rule will stop companies who offer consumers false promises of reducing credit card debts by half or more in exchange for large, up-front fees. Too many of these companies pick the last dollar out of consumers‘ pockets – and far from leaving them better off, push them deeper into debt, even bankruptcy.
Since the start of the recession, the Better Business Bureau has received more than 3,500 complaints about debt settlement companies. Customers complained that they ended up deeper in debt or were sued by creditors after failing to make payments. The bureau did not separately track complaints against the industry prior to the recession.
Debt settlement companies often charge an upfront fee, typically a percentage of the customer’s outstanding balance. In exchange, the company promises to negotiate with creditors to reduce or eliminate the debt, sometimes by as much as half.
The new FTC regulations also require debt settlement companies to disclose to customers how long it will take to get results, how much it will cost, and any negative consequences that could arise from the process.
Specifically, the three other Telemarketing Sales Rule provisions to take effect on September 27, 2010, will:
– require debt relief companies to make specific disclosures to consumers;
– prohibit them from making misrepresentations; and
– extend the Telemarketing Sales Rule to cover calls consumers make to these firms in response to debt relief advertising.
For example, debt settlement companies will now have to inform customers that they can go deeper into debt when they hire a debt settlement company. This is because customers stop making payments on their loans, and late fees and interest charges continue piling up.
Customers are also often required to start setting aside money in a separate account maintained by the debt settlement company. This money is intended to eventually pay off any remaining debt Under the new rule, however, companies will only be able to require such an account if it’s maintained at an independent financial institution under a customer’s name. The customer must also be able to withdraw the money at any time without penalty.
The amendments to the FTC’s telemarketing sales rule apply to any debt relief companies that sell services over the phone. They do not apply if the initial contact is in person, or if the services are rendered entirely online.
The new rule will cover the vast majority of the debt settlement industry, however, because most companies use TV and radio ads to advertise toll-free phone numbers for customers to call, said Allison Brown, an attorney with the FTC.
The Final Rule covers telemarketers of for-profit debt relief services, including credit counseling, debt settlement, and debt negotiation services. The Final Rule does not cover nonprofit firms, but does cover companies that falsely claim nonprofit status. Over the past decade, the FTC and state enforcers have brought a combined 259 cases to stop deceptive and abusive practices by debt relief providers that have targeted consumers in financial distress.