If you're drowning in credit card debt, the debt relief industry might throw you a life preserver — or pull you under.
Settling your debt for half or less than what you owe sounds great. It's no wonder that consumers are bringing nearly $30 billion of debt into the debt settlement process each year. However, fraud and misrepresentation are common, according to federal and state investigators.
A New York Attorney General's investigation found more than 500 people paid more than $1 million in fees to one settlement company, but hardly any of them received the promised 25 to 40 percent savings. In fact, nearly half the 64 people who completed the program during the three-year investigation ended up paying more to settle their debts than they owed when they started the process. The Better Business Bureau says it has received thousands of complaints against debt settlement companies.
The problems start with advertising, which may feature inflated claims of success, dubious money-back promises, failure to disclose the downside of settlement and even implied links to government programs. However, the real crux of the issue is that nearly all debt settlement companies collect most of their fees in advance before consumers can know how much, if any, relief they're going to get. The settlement process often takes several years, during which the debt grows exponentially with interest and late fees and creditors attempt to collect through dunning letters, phone calls and lawsuits. Many people who hoped to settle end up filing for bankruptcy.
In spite of the problems, desperate debtors increasingly look to settlement companies as their last hope to avoid bankruptcy. That's a role once filled by credit counseling agencies, the vast majority of which are not-for-profits charging modest fees. These agencies traditionally offer debt-management plans that require 100 percent repayment over five years. Help takes the form of interest rate reductions, fee waivers and budgeting advice. When it works right, people dig out from under their debt and preserve their credit ratings.
"People are getting to us too late," said David Jones, president of the Association of Consumer Credit Counseling Agencies. "With the housing situation, loss of jobs and pay cuts, it's an almost impossible situation. It's down to 10 to 15 percent of those who come to us that we can actually help. In some areas it's less than that."
Some not-for-profits are now expanding into a new model for debt settlement, which they prefer to call debt resolution. The model is based on getting creditors to agree up front to accept a payment plan instead of a lump sum. (The for-profit model settles debts one at a time as consumers save up enough money to make a lump sum settlement offer.)
If creditors get on board, the new model will drive the for-profit companies out of business, predicts Robert Manning, a professor at New York's Rochester Institute of Technology, who heads the Responsible Debt Relief Institute. He has developed an assessment process to determine which option — debt management, debt resolution or bankruptcy — is the best fit for a debt-burdened consumer. The theory is that creditors will be more willing to reduce debt if they have confidence that consumers really can't afford to pay more.
There are also are efforts to clamp down on for-profit companies by eliminating or limiting up-front fees. Proposals are currently pending in the U.S. Senate and the Federal Trade Commission.
In the meantime, bankruptcy filings are up about 15 percent so far this year and expected to hit 1.6 million.
Helen Huntley is former St. Petersburg Times personal finance editor and currently a fee-only financial adviser with Holifield Huntley Financial Advisers in St. Petersburg (holifieldhuntley.com).