Losses Mount as Debt Settlement Firms Face New Rules

In just a few weeks, new federal regulations will go into effect that will put an end to a particularly unscrupulous kind of debt settlement scam. But amid the countdown to the stricter rules, consumers are already beginning to report the loss of thousands of dollars from supposed escrow accounts that had been set up by debt settlement firms to pay their bills.

Christopher Viale, CEO of a nonprofit called Cambridge Credit Counseling, says "This is probably the biggest consumer harm issue that has ever happened in our country, yet the media has barely covered it at all. It's a shame."

As I wrote in a DailyFinance article on Aug. 31, an estimated 9 million consumers have invested money with these debt settlement companies in hopes of lowering their credit card debts by up to 50%. But as of Oct. 27, a new Federal Trade Commission rule will ban the practice of taking advance fees to arrange settlements, which many fear will cause hundreds of the settlement firms to go out of business, taking the clients' money with them.

"It's already happening," Viale says. "Consumers are calling us to say, 'I was with this company and I called the number and it's disconnected and there is no money in my account now."

State Laws May Help Some Consumers
Fight Back

There is nothing to stop debt settlement firms from taking on new business now, despite the approaching deadline next month and the cable TV airwaves are being saturated with advertising. FTC officials say they will investigate cases of individual fraud, but there is nothing else they can do to prevent settlement companies from stealing consumer money that has been set aside to pay their settlement fees.

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Viale says there are a number of steps consumers can take to attempt to safeguard money already deposited with debt settlement firms. First, debt settlement is illegal in 12 states: Arizona, Georgia, Hawaii, Louisiana, Maine, Mississippi, New Jersey, New Mexico, New York, North Dakota, West Virginia and Wyoming. If a consumer in one of those states set up a debt settlement account, they can call their state attorney general's office and file a complaint.

Furthermore, many states set caps on the amount that debt settlement companies can charge in fees. To find out what their local regulations allow, consumers should contact the licensing division of the state financial services department to see if they have been overcharged.

Viale says the threat of such an action by the consumer is usually enough to induce debt settlement companies to provide a full refund, because some of the firms fear getting entangled in the courts.

"Consumers are going to need to make a stink to try and get their money back as quickly as they can," Viale says. "Some of the really bad actors out there may be waiting to shut their doors and walk away with the money."

Collecting Thousands in Fees With No Result

Another possible escape for consumers, Viale says, is that if they have been with a debt settlement firm for less than six months and they contact a nonprofit debt management advisor like Cambridge, they can often get their credit card accounts reinstated if the bank involved has not yet sold the account to a collection agency or lawyer. In that way, they can make arrangements to resume paying their bills and avoid the legal problems of not paying their bills.

Nonprofit firms like Cambridge offer honest debt management plans, which take the consumer's credit card debts and wrap them together. The consumer then pays a regular amount plus a small service fee -- usually around $23 a month -- and the debt management firm pays the credit cards off in four to five years. All of the debt gets repaid, but the credit card firms often waive some interest and fees.

In contrast, the for-profit debt settlement firms charge thousands of dollars and are rarely able to convince credit card companies to make settlements. Before the recent FTC ruling, they could still collect thousands of dollars in fees even if they didn't settle the debt.

Viale says the majority of debt-laden consumers don't need a debt management plan, just a tailored household budget that cuts unnecessary spending.

He added that there are a handful of firms among the estimated 2,000 debt settlement companies that provide a legitimate service to consumers and only take a fee after they have successfully negotiated a settlement.