Colorado Moves to Lower Debt Settlement Fees

A reader forwarded me a copy of this document from the State of Colorado regarding debt settlement.

It contains some interesting sections. For example there is this one.

Recommendation 2 – Limit settlement fees to 15 percent of the debt forgiven from a completed settlement.

“A Settlement Provider negotiates with a creditor to convince it to forgive a portion of what a consumer owes on unsecured debt.
Debt settlement is an appealing idea — consumers can settle their debts for a portion of what they owe. It is aggressively marketed as an alternative to bankruptcy, and it is also purported to save consumers more money than management plans or other means of handling debt.

Consumers who work with Settlement Providers are hoping to become debt free, but many end up in a worse financial situation than when they began.

Sunset criteria question whether regulation by the agency is necessary to protect the health, safety and welfare of the public, and if it is necessary, whether the existing statutes establish the least restrictive form of regulation consistent with the public interest.

In 2011, the General Assembly repealed the settlement fee cap. Prior to its repeal, Settlement Providers were limited to charging, in aggregate fees, 18 percent of the total amount of principal debt owed.

The General Assembly took this step in response to a change in federal law, which prohibits Settlement Providers from taking advance fees and requires them to obtain prior approval from the client before settling a debt. The idea is that Settlement Providers are now paid for performance.

The Federal Trade Commission amended the Telemarketing Sales Rule after it determined that Settlement Providers were charging financially distressed consumers thousands of dollars to settle their debts and then failing to settle the debts or provide refunds as promised, and as a result consumers were getting even further into debt.

Now, Settlement Providers can no longer collect substantial fees without settling any debt for the consumer. However, this does not address the fact that, in Colorado, Settlement Providers are charging substantial fees to consumers who are already in serious financial trouble.

Since the 18 percent fee cap was removed, the settlement fees in Colorado have soared as high as 25 percent. This is a seven percent increase over the original fee cap.

In 2012, Colorado residents paid on average 55 percent of the principal debt owed to creditors to settle debts and up to 25 percent of the total debt owed to Settlement Providers. In total, consumers paid an average of 80 percent of the original debt owed. On top of that, any debt that was forgiven was reported to the IRS as taxable income, and this does not take into account the increased balances of any debt that was not forgiven.

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For those who settle a portion of their debts, the amount they actually save is further reduced by the growth in any debt that is not settled. According to data reported to the Colorado Department of Law, 74 percent of consumers do not complete a settlement plan in five years.

Further, the settlement amount paid on an individual basis varies depending on the individual debts, and the average rate of settlement varies considerably from year to year, fluctuating between 51 and 62 percent over the five-year period under review.

This all occurs under the mantle of debt relief or debt forgiveness. When everything is taken into account, most consumers are negatively impacted by working with Settlement Providers, and for those who are successful in settling their debts, the amount of debt relief they obtain is significantly reduced by the fees charged by settlement providers.

While Settlement Providers are currently charging fees as high as 25 percent based on the principal amount of debt enrolled in a settlement plan, the fees they charge could increase even more.

At this time, Colorado law allows a Settlement Provider to charge fees up to the total principal amount of debt when the fees are added to the aggregate of offers of settlement obtained by the provider. Because consumers will have to pay taxes on any debt forgiven, they could potentially end up owing even more than when they enrolled in a settlement plan. Clearly, this is not debt relief.

At 18 percent, the Colorado fee cap that was in place prior to 2011 was already lenient.

The reason for removing the fee cap in 2011 was that Settlement Providers would be paid for performance since they could no longer collect large fees and fail to deliver on the promised services. However, they are not, in fact, being paid for performance. By basing fees on the total amount of debt owed, Settlement Providers are provided a financial incentive to acquire clients with large amounts of debts, not to obtain the best settlement for a client.

Setting a more reasonable fee cap based on the amount of debt forgiven and ensuring that a settlement is completed would guarantee that Settlement Providers were truly paid for performance.

Fee caps in some states are set at 10 to 15 percent of the amount of debt forgiven, not the amount of debt owed. Structuring the fees based on savings would create a financial incentive for Settlement Providers to obtain the best possible settlement for the client, and setting a reasonable fee cap would ensure that debt settlement provides some benefit, taking into account all the costs of a settlement agreement including income tax and the inherent risks of the settlement process.

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Therefore, the General Assembly should limit settlement fees to 15 percent of the debt forgiven, based on the principal balance of the original debt enrolled, on a completed settlement.

Most Debt Settlement Companies Not Authorized in Colorado

According to this chart in the document there are only 7 registered debt settlement providers who are authorized to operate in Colorado.

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And I found this to be interesting as well.

Management refers to Debt Management (Credit Counseling)
Management refers to Debt Management (Credit Counseling)

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According to the States data, the results obtained by credit counseling groups is not substantially better than for debt settlement. Of the consumers who enrolled in 2008, by 2012 only 24% had completed the debt management program.

Of those 2008 enrollees, 9 percent were still paying off debts but 67 percent had terminated the plan.

In comparison, of the 2008 debt settlement enrollees, 26 had completed a settlement plan by 2012, about 6 percent were still in the program and 68 percent terminated before settling all the debts in the settlement plan.


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Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.
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