Demand has surged for debt resolution options as more Americans are unable to pay their debts. The Debt Negotiation/Settlement industry has exploded in recent years. Hundreds of private for-profit companies and law firms operate in this space - often fueled
by telemarketing boiler rooms. There are many reasons why the debt settlement industry is under scrutiny by the FBI, Secret Service, State Attorney Generals, and other financial crime regulators: deceptive marketing, high fees, poor service, severe consequences
for customers – they’ve got it all.
How Debt Negotiators Work - Fee Models and Business Practices
The basic pitch is to convince consumers to discontinue any payments to their creditors in the hope that your creditors will write off the debt and reclassify it as less collectible, and ultimately agree to settle for a greatly reduced amount. They instruct
their clients to stop paying credi?tors and to make payments to their company instead, promising to offer a settlement to a creditor as soon as they’ve accumulated enough of the client’s cash to do so.
Typically, customers are told to set up a separate bank account from which they make payments each month to cover the negotiator’s own fees and to build up cash that will later be used for creditor payoffs. Settlement companies often emphasize that they do
not control these funds, or that the account is managed and even disbursed by the client. However, some debt negotiators do structure their business in a way that enables them to withdraw funds directly.
Fee structures vary, but the two primary pricing methods are
1) a percentage of the projected savings, which runs anywhere from anywhere from 15%-35%. This is a “reverse contingency” fee since it’s based on the estimated savings to be achieved, rather than money actually won
2) a percentage of the total balances at the outset of the “plan”. These can range from 13% to 20%.
These fees are collected in the beginning months of the client’s plan, which is typically set up for 2 or 3 years. Debt settlement companies don’t contact the creditor until the fund has accumulated enough cash to begin negotiations on the debt, and since the
fees take up most of the client’s accumulated cash in the first several months, this doesn’t happen soon. Meanwhile the account advances towards charge-off and punishing late and over-limit fees can accrue.
They also charge ongoing monthly fees for “administration” that can range between $19 and $85 per month, according to one industry association.
Misleading Ads and Lack of Transparency
Advertising in the industry is a combination of telemarketing, list brokering, spam, slick TV and radio broadcasting, and online media. Third party lead generators front for paying referral receivers with slick ads touting “government programs” and large debt
reductions. Some debt settlement companies are outright telemarketing scams and Ponzi schemes, relying on a constant inflow of new debtors’ money to keep their marketing machine oiled. The business model relies on unearned benefit.
The usual outcome for clients in debt settlement plans is that they continue to be harassed by creditors, fees and interest accumulate, debts go to charge-off after 180 days and then to outside collection agencies, attorneys, or junk debt buyers who will eventually
file lawsuits. Debts are seldom settled, clients’ credit is ruined, and many people end up filing bankruptcy. In the end, they’ve paid more than if they’d never contacted the company and refunds are practically impossible to get.
It’s hard to find another industry business model that sets itself up for failure like Debt Settlement. The 2-3 year “plans” that they offer are doomed from the outset. Legal action during the first 12 months of delinquency is rare (delinquent accts are charged
off after 6 months and lawsuits during the next 6 month period are uncommon). As the account runs into the next 12 months of delinquency however lawsuits become more likely – so the industry standard “plan” of 2-3 years becomes a Catch-22. Debtors would do
better to figure on a maximum of 18 months in which to accumulate money for a settlement and try to deal with their creditors themselves. An individual’s total debt may actually increase in these plans since interest, late and over-limit fees can be tacked
on to the original balance.
Cancelled debts of $600 or more are considered taxable income by the IRS. For example, if a debt is reduced from $20,000 to $10,000, the consumer may have to pay taxes on the $10,000 of “forgiven” debt. Additional tax payments reduce the savings from negotiated
settlements. Disclosure practices vary widely within the industry but it’s clear that many consumers are unaware of the potential tax liability from this type of debt reduction (if it actually happens).
A patchwork of laws and regulations affect Debt Negotiators. Some states consider providing debt settlement services to constitute the Unauthorized Practice of Law (UPL). With some exceptions, companies that negotiate consumers’ debts and collect money for
the purpose of paying creditors are subject to regulation and must be licensed as a prorater (in California the Department of Corporations licenses proraters). Proraters are also subject to fee limitations.
Exceptions to the laws that apply to proraters, including licensing, are companies that negotiate with creditors on your behalf but do not collect the money to pay the creditors (and thus do not come under the definition of a prorater), nonprofit community
service organizations that meet required criteria, and licensed attorneys who render services in the course of their practice as an attorney.
Many Debt Negotiators who are exempt from the licensing requirement and fee limitations because they themselves do not collect and distribute payments can be risky to deal with simply because of that exemp?tion. They can collect whatever fees they want but
may never contract creditors or negotiate settlements.
Debt Negotiators have no legal authority to force creditors from continuing with collection efforts, and creditors will likely ignore their demands. If monthly payments aren’t made, creditors will pursue collection efforts which may include turning the account
over to a collection agency, selling the account to a junk debt buyer, or filing suit against the cardholder to recover the unpaid balance. In fact, a Debt Negotiator may want the account to go to collection or be sold, since a settlement will be more easily
achieved with a collection agency or junk debt buyer.
TrustLink experience with debt settlement firms
TrustLink's history overall with debt settlement companies has been decidedly negative and Debt Negotiators/Settlement companies are high on the list of companies most complained about through reviews on our website and on our Ask The Community forum. Consumers
typically complain that after paying high fees, little or nothing is done to reduce their debts and their credit ratings are ruined in the process. Many consumers are sued by creditors because in order to participate in the plans they are told to stop making
payments. The Debt Settlement/Negotiating industry is very different in its scope of services than true nonprofit Credit Counseling. It is not Debt Consolidation, which is a loan refinance.
Debt Negotiation questions on Ask The Community
Debt Settlement questions on Ask The Community
Regulatory Outlook for This Industry
The Federal Trade Commission does not look favorably upon the debt settlement industry. The FTC has scrutinized the business practices and fee schedules commonly used by these settlement companies, in particular the timing of fees (usually front end loaded)
and the high level of these fees and they are on a path to implement very strict regulations on fees and disclosures. A good roundup of the recent FTC public forums, investigations, and Notice of Proposed Rulemaking on debt settlement/negotiation can be found
Red Flags: avoid any company that promises to settle your debt if it:
• touts a “new government stimulus program” or “new laws” to bail out personal credit card debt
• guarantees it can make your unsecured debt go away
• tells you to stop communicating with your creditors
• tells you it can stop all debt collection calls and lawsuits
• guarantees that your unsecured debts can be paid off with pennies on the dollar
• requires that you pay most or all of the fee within the first few months
The FTC has published a pamphlet (dated March 2010) on debt settlement: