As boring as it sounds, I was actually reading the testimony of the expert witnesses at the recent committee meeting on the bill and found the segment below to be of specific interest.
It appears that his bill would help to create a set of federal legislation that is so desperately needed for the debt settlement industry. The debt settlement trade associations should embrace such regulation in hopes of making the bad actors go away so as to not lead to a downfall of the entire debt settlement industry.
Testimony of Kathleen Keest, Senior Policy Counsel, Center for Responsible Lending:
Debt Settlement: The Business Model Is Inherently Harmful to Vulnerable Consumers
As we discussed earlier, many Americans are under a serious burden of debt. The decrease in the value of the major asset most families own, their homes, and the loss of jobs has exacerbated those difficulties. Keeping ahead of that debt by churning it, from one credit card transfer to another, or a debt consolidation mortgage refinance was only a short term solution in the first place, and the current crisis has shut that option off in any event. (Westrich, Tim and Weller, Christian E., “House of Cards, Consumers Turn to Credit Cards Amid the Mortgage Crisis, Delaying Inevitable Defaults,” Center for American Progress, February 2008.) Moreover, some families in financial trouble are continuing to use their credit cards to pay for essential purchases and are therefore attempting to stay current on their credit card loans but not their mortgage payments, a shift in behavior from past economic crises that will likely lead to further deterioration of their financial condition. (Kathy, “More Americans Using Credit Cards to Stay Afloat,” USA Today, February 28, 2008.)
It is unsurprising, then that consumer demand for debt reduction or debt management assistance has increased. (“Look Out for That Lifeline, Debt-Settlement Firms are Doing a Booming Business—And Drawing the Attention of Prosecutors and Regulators,” BusinessWeek, March 6, 2008.) And, it is unsurprising, too, that some of those who step up to “help” are scammers. There are different debt management business models. As discussed below, the credit counseling model, though not without its current problems, can with proper protections and under certain circumstances benefit
consumers. The debt settlement model, on the other hand, does not—because the model
itself is inherently problematic.
In the last decade, the number of debt settlement companies operating nationwide has increased from very few to as many as two- to three- thousand. These are typically for-profit entities, unaffiliated with credit card companies. Sometimes calling themselves credit counselors, they promise to painlessly reduce consumers’ credit card debt through a variety of expensive, harebrained and harmful schemes.
In March, the Texas attorney general sued the debt settlement firm that calls itself the largest in the country, Credit Solutions, on claims of “false, deceptive and misleading acts and practices.” (David Streitfeld, An Inquiry Into Firms That Offer to Cut Debt , N.Y. Times, May 7, 2009.) Just last week, New York’s Attorney General, calling the debt settlement industry a “rogue industry,” issued subpoenas to 14 of these debt settlement companies to inquire into their fee structures and whether they are indeed offering the relief they advertise. (Id. Mr. Andrew Cuomo said he issued subpoenas to the following firms: American Debt Foundation Inc., American Financial Service, Consumer Debt Solutions, Credit Answers L.L.C., Debt Remedy Solutions L.L.C., Debt Settlement America, Debt Settlement USA, Debtmerica Relief, DMB Financial L.L.C., Freedom Debt Relief, New Era Debt Solutions, New Horizons Debt Relief Inc., Preferred Financial Services Inc., U.S. Financial Management Inc. (operating as My Debt Negotiation) and Allegro Law.)
These state actions are encouraging, but the industry remains very loosely regulated, and its abuses are flagrant and highly destructive.
- The credit counseling business model is different from the debt settlement model.
Credit counseling was created in the mid-1960s by credit card companies that saw an opportunity to recover overdue debts, and in the beginning, most of the agencies were non-profit. These agencies offered a feature debt reduction service, the debt management plan (DMP), in addition to financial and budget counseling and community education sessions.
Under a DMP, a consumer sends the credit counseling agency a lump sum, which the agency then distributes to the consumer’s creditors. In return, the consumer is supposed to receive a break in the form of creditor agreements to waive fees and lower interest rates. Consumers also gain the convenience of making only one payment to the agency rather than having to deal with multiple creditors on their own.
The credit counseling industry has not been without its share of serious abuses.
Over the years, as creditors reduced the percentage of debt collected they shared with the agencies, the agencies curtailed some free counseling services and raised consumer fees for DMPs. By the late 1990s, complaints about deceptive practices, improper advice, excessive fees and abuse of non-profit status had sharply increased. (Loonin, Deanne; Plunkett, Travis; “Credit Counseling in Crisis: The Impact on Consumers of Funding Cuts, Higher Fees and Aggressive New Market Entrants;” National Consumer Law Center and Consumer Federation of America; April 2003; http://www.consumerfed.org/pdfs/credit_counseling_report.pdf.) In response, regulators, policymakers, and state attorneys general conducted widespread investigations, (“Profiteering in a Non-Profit Industry: Abusive Practices in Credit Counseling,” Report Prepared by the Permanent Subcommittee on Investigations of the Committee on Homeland Security and Governmental Affairs, United States Senate, April 13, 2005, http://frwebgate.access.gpo.gov/cgibin/getdoc.cgidbname=109_cong_reports&docid=f:sr055.pdf. By late 2006, the IRS had investigated 63 agencies that brought in more than half the revenue of the entire credit counseling industry for violating their non-profit status. http://www.irs.gov/charities/article/0,,id=156827,00.html. The IRS has since reported that it has “revoked, terminated or proposed revocation of over half of the organizations examined, representing 41 percent of revenue in the industry,” http://www.irs.gov/charities/article/0,,id=156829,00.html.) and some state lawmakers put new laws on the books to curb abusive practices. (Some states used the Uniform Debt Management Services Act proposed in 2005 by the National Conference of Commissioners on Uniform State Laws as a model and others acted independently to adopt standards regarding business practices and fees.)
In the last decade, credit card companies had been reducing the concessions they are willing to give debtors participating in DMPs. The Consumer Federation of America (CFA) found that some major creditors actually increased the interest rate they charge in credit counseling, while others have kept these interest rates high for many consumers. (For example, when CFA surveyed interest rates in credit counseling in 1999 and 2003, Bank of America was a model for the rest of the industry, charging 0 percent APR for those in a DMP. Consumer Federation of America, “Large Banks Increase Charges To Americans In Credit Counseling, New Practices Will Hurt Consumers On The Brink Of Bankruptcy, July 28, 1999. National Consumer Law Center, Consumer Federation of America, “First-Ever Study of Credit Counseling Finds High Fees, Bad Advice and Other Abuses by New Breed of ‘Non-Profit’ Agencies,” April 9, 2003; http://www.consumerfed.org/releases2.cfm?filename=040903ccreport.txt. Now, Bank of America has a range of interest rates from 1 percent all the way up to 16 percent. There is not a single major credit card issuer right now that charges less than 5 percent APR for all of its clients in DMPs. (JP Morgan Chase comes the closest, at 6 percent.) Capital One charges a 15.9 percent rate, unless the client enters counseling with a lower rate. Discover charges a range of rates that go as high as 15.9 percent as well. Consumer Federation of America, Testimony before the U.S. Senate Committee on Science, Commerce and Transportation, Feb. 26, 2009.) This trend calls into question the viability of the DMP as a useful tool to help consumers reduce their debt. In a hopeful sign, the National Foundation for Credit Counseling recently announced that major creditors had agreed to offer “hardship” DMPs with more significant interest rate reductions to some consumers in credit counseling. (Michelle Singletary, As Recession Deepens, Even Credit Cards’ Minimums Can Become a Burden, Washington Post, Apr. 23, 2009.) CFA has actively supported efforts to eliminate regulatory obstacles that inhibit issuers from authorizing DMPs that significantly reduce the principal (not just the interest charges) that consumers owe (The OCC and other financial regulatory agencies rejected a request made by CFA and the Financial Services Roundtable on October 29, 2008 to permit a pilot project that would allow some credit counseling agencies to offer some consumers reduced principal DMPs over a period of up to 60 months. Current guidance requires that reduced principal “settlements” must generally be paid in full within three to six months. Multi-year, reduced principal payment plans are not allowed unless the issuer charges off the entire loan before offering the settlement.) and to limit consumers’ tax liability when such principal is reduced. Reduced principal DMPs could not only help many families in debt trouble stay solvent, but also create a legitimate, pro-consumer alternative to debt settlement scams, as we discuss in the next section.
With appropriate protections, then, the credit counseling business model is not harmful and can be helpful to some consumers. An initial phase of research directed by CFA and American Express found that credit counseling can be effective in helping consumers to improve their creditworthiness over time. (Staten, Michael E., Barron John M., “Evaluating the Effectiveness of Credit Counseling,” May 31, 2006; http://www.consumerfed.org/pdfs/Credit_Counseling_Report061206.pdf. Consumers who were recommended for a DMP by agencies and chose to start payments had a significantly lower incidence of bankruptcy, as well as improved bankruptcy and delinquency risk scores, over the two years following counseling than did those who were recommended for a DMP and chose not to start.) And consumer groups often advise consumers that a DMP could be helpful in reducing some unsecured debts, depending on whether the financial condition of the debtor is stable or deteriorating, and on the interest rate reduction offered by creditors reduce some unsecured debts. (For a more detailed discussion of credit counseling issues, see CFA’s testimony before the U.S. Senate Committee on Science, Commerce and Transportation, February 26, 2009.)
- The debt settlement business model is inherently problematic.
Debt settlement involves negotiating with creditors to reduce the principal amount the consumer owes and to pay this reduced amount over a fairly short period, usually in one or two lump sum payments. Unlike most credit counseling agencies, debt settlement and debt negotiation companies are usually for-profit businesses. Settlement services are different from credit counseling (or debt management) mainly because settlement companies do not send regular monthly payments to creditors. Instead, these agencies generally maintain a consumer’s funds in separate accounts— or direct consumers to deposit savings in an account that they can observe but do not control— until the company believes it can settle the consumer’s debts for less than the full amount owed. Typically, debtors can only afford to pay off their creditors sequentially, saving up enough money (after upfront fees are paid) to make an offer to one creditor, then saving again until there is enough to offer a second settlement, and so on. Many companies have advised consumers to stop paying debts as a condition of participation in the program. Debtors pay a variety of fees for this service, including enrollment fees, monthly maintenance fees and a settlement fee, which is usually a percentage of the forgiven amount of debt.
The Federal Trade Commission and, as mentioned earlier, attorneys general in several states have brought actions against a number of these agencies. Appendix B provides significant details about the range of deceptive, fraudulent, and harmful practices that these companies used that the FTC has uncovered, which can be summarized as follows:
- Settlement firms often mislead consumers about the likelihood of a
settlement. Evidence from debt settlement investigations indicate that a large number of consumers never complete a debt settlement program. One North Carolina assistant attorney general estimates that 80 percent of consumers drop out of debt settlement plans within the first year. (“Look Out for That Lifeline, Debt-Settlement Firms are Doing a Booming Business—And Drawing the Attention of Prosecutors and Regulators,” BusinessWeek, March 6, 2008.) A receivers’ report on the National Consumers Council, a purported non-profit debt settlement organization that was shut down by the FTC in 2004, found that only 1.4 percent of NCC
customers settled with all their creditors. (Robb Evans and Associates LLC, “Report of the Temporary Receiver, May 3, 2004 – May 14, 2004, First report to the Court.”) 43 percent of their clients cancelled the program after incurring fees of 64 percent of the amount remitted to NCC.
- Unlike credit counseling agencies, settlement firms cannot guarantee to consumers that the creditor will agree to a reduced payment if certain conditions are met. In fact, some creditors insist that they won’t negotiate with settlement firms at all, (Robert Berner and Jessica Silver-Greenberg, “Look Out for That Lifeline, Debt-Settlement Firms are Doing a Booming Business—And Drawing the Attention of Prosecutors and Regulators,” BusinessWeek, March 6, 2008.) or that they will initiate a collections action if they learn that a debt settlement company is negotiating on behalf of a consumer.
- Settlement firms often mislead consumers about the effect of the settlement process on debt collection and their creditworthiness. Withholding payment to settle multiple debts is a very long process. Meanwhile, additional fees and interest rates continue to build up, creditors continue to try to collect on unpaid debts, and consumers’ creditworthiness continues to deteriorate. Some firms still advise consumers not to pay debts, either implicitly or explicitly. (FTC Investigation of Edge Solutions, Inc. and Money Cares, Inc. aka The Debt Settlement Company and The Debt Elimination Center; Pay Help, Inc.; Miriam and Robert Lovinger, Press release, Aug. 5, 2008 at: www.ftc.gov/opa/2008/08/edge.shtm) Others firms say they never tell consumers not to pay their debts but only accept clients who have already stopped paying. Moreover, many settlement firms have not followed through with promises that they will stop collection calls from creditors. In fact, under the Fair Debt Collection Practices Act, consumers can only request that third party collection efforts stop—not collection attempts by a credit card company on its own behalf.
- Settlement firms charge such high fees that consumers often don’t end up saving much to make settlement offers, which is why so many drop out of settlement programs. Debt settlement firms typically require consumers to pay fees of between 14 and 20 percent upfront (and as high as 30 percent) (Consumer Federation of America, Testimony before the U.S. Senate Committee on Science, Commerce and Transportation, Feb. 26, 2009.) before they receive a settlement. It is often not made clear to consumers that a hefty portion of the payments they make in the first year will go to the firm, not to their reserve fund or creditors. (Berner and Silver-Greenberg, BusinessWeek, March 6, 2008.) Many firms also charge monthly fees to maintain accounts, as well as a “settlement fee” of between 15 and 30 percent of the
amount of debt that has been forgiven. (See, e.g., FTC claims against Better Budget Financial Services (BBFS) in Appendix B (BBFS promised to negotiate with consumers’ creditors for a non-refundable retainer fee, monthly administrative fees of $29.95 to $39.95, and 25 percent of any savings realized by a debt settlement)
- As a result of high fees, consumers targeted by debt settlement companies are
generally the least likely to benefit. Some firms will work only with insolvent consumers who are unemployed or those in a hardship situation. (Consumer Federation of America, Testimony before the U.S. Senate Committee on Science, Commerce and Transportation, Feb. 26, 2009.) Many have minimum debt requirements of $10,000 to $12,000. Consumers facing serious hardship with very high debts are, of course, the least likely to be able to afford the hefty payments that are charged. Settlement firms also appear to make no distinction, as a good attorney would, between consumers in these hardship situations who are vulnerable to legal judgments to collect and those who are not.
- It is unclear what professional services most debt settlement companies offer to assist debtors while they save money to pay for a settlement. Serious negotiation with creditors cannot commence until a significant settlement amount is saved, which could take years once high fees are paid. A persistent complaint by consumers is that settlement companies do not contact creditors at all in some cases.
- Settlement firms often mislead consumers about the likelihood of a
- The impact on consumers is devastating.
These practices clearly meet the test for substantial injury; indeed, the combined impact on consumers of these practices can be devastating. To get a sense of the impact on the many indebted borrowers for whom the debt settlement business model does not work, CFA examined some of the thousands of debt settlement complaints that are on various consumer review web sites. Here are a few summaries of the stories we found (all from the past eight months), which are generally consistent with claims made by the FTC in its investigations:
- One (anonymous) consumer was convinced by a debt settlement company that it had strong relationships with major creditors and that its services would be a good alternative to bankruptcy. After she signed up with the settlement company, she was instructed to stop making payments to creditors. She later found out that the extent of the settlement company’s involvement amounted to sending “power of attorney” letters to the creditors. Without help from the company she hired, she is now facing at least two collections lawsuits alone.
- One woman was persuaded to stop paying her creditors and to start paying the debt settlement company over $800 a month with the promise that her creditors would stop their collections calls and that she could reach a good settlement on her credit card balance. The settlement company took the money, but no settlements ever took place, and creditors never stopped calling. After seven months of no progress with her accounts, she stopped paying the company’s fees. Without being able to get a refund of the more than $5,000 she paid in fees, she is now saving money for a bankruptcy lawyer. After a legal firm later acquired her accounts, she discovered that the original settlement company routinely dealt with other customers in the same way.
- After hearing nothing from his debt settlement company for several months, Chris from Maryland attempted to respond personally to a credit card collections letter. The debt settlement company later scolded and threatened him because he contacted the creditor directly. He realized that the company was not keeping up its end of the bargain, and he decided that the $300 per month he was paying in fees was not money well spent. He has tried to sever his ties with the settlement company, but they continue to ignore his requests.
- “T” from Arizona regularly saw television advertisements for a particular debt settlement company and thought it appeared legitimate. He called the company and was promised that his payments would be only $300 a month. The company collected his personal financial information and instructed him to stop paying his creditors. After four months and over $1,500 in fees being automatically drawn from his bank account, the consumer found out that no creditors had been paid. He eventually had to put a “stop payment” order on his bank account to prevent the settlement company from automatically withdrawing what they pleased. The consumer is now stuck with a damaged credit report, excessive fees, and no debt settlements.
- Frank from New York was directly contacted by a debt settlement company after visiting the company website. After a promise that the company would settle his debts, he decided to accept the $250 per month fee. Nearly a year later, with no progress in debt settlements, he stopped hearing from them. After many unanswered calls and emails, he finally received a response from the company that he would get a partial refund. Since then the company has ignored his efforts to receive the refund and his debts remain unsettled.
Creditors obviously must share some responsibility for the growth of the debt settlement industry. For one thing, some credit card issuers are knowingly doing business with these firms. For another, there clearly is consumer demand for a legitimate debt reduction approach that offers more relief than traditional credit counseling but is not as far reaching as bankruptcy.
Ultimately, it appears clear that the business model for debt settlement is structurally flawed. The essential promise made by debt settlement firms to the public, that they can settle most debts for significantly less than what is owed, is often fraudulent. While there is general consensus that credit counseling, if done well, can provide significant benefits for some financially distressed consumers, no such consensus exists for debt settlement. Debt settlement firms should have to prove that, in the face of significant evidence to the contrary, their business model can and does actually help more than a few financially distressed consumers.
Recommendations regarding debt settlement:
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Congress should enact legislation mandating that the FTC issue a directed rulemaking on debt settlement and including minimum baseline standards.
To date, debt settlement has been regulated primarily at the state level. Seven states have banned debt settlement. (“Look Out for That Lifeline, Debt-Settlement Firms are Doing a Booming Business—And Drawing the Attention of Prosecutors and Regulators,” BusinessWeek, March 6, 2008.) Four more have adopted limited restrictions on the practice proposed by the National Conference of Commissioners on Uniform State Laws. (Uniform Law Commissioners, “A Few Facts about the Uniform Debt-Management Services Act of 2005, http://www.nccusl.org/Update/uniformact_factsheets/uniformacts-fs-udmsa.asp. The National Consumer Law Center and Consumer Federation of America opposed including provisions regulating debt settlement firms in the same law that regulated debt management and credit counseling because the businesses are so different. The highly questionable debt settlement business model necessitates a different and more stringent regulatory framework that does not legitimize the debt settlement.) A number of other states have restrictions on debt management or adjustment that do not explicitly pertain to the practice of for-profit debt settlement, but cover it. States can also deploy laws regarding credit repair, the unauthorized practice of law, and unfair and deceptive practices (UDAP) against selected debt settlement practices. (Loonin, Deanne, National Consumer Law Center, “An Investigation of Debt Settlement Companies: An Unsettling Business for Consumers,” March 2005.)
However, the growing prevalence of debt settlement companies, despite these state efforts, is clear indication that further action—a federal minimum standard—is needed. Congress should enact a federal law setting a strong minimum standard based on the best state laws directed specifically at debt settlement. The law should direct the FTC to implement rules and regulations necessary to effectuate its purpose and give the FTC enforcement authority. The FTC has used the FTC Act well to pursue settlement firms that have used unfair and deceptive practices and would be greatly aided by directed rulemaking authority.
At the very least, the minimum legislated standards should:
- Require debt settlement firms to inform consumers upfront whether or not creditors will participate in the plan;
- Prohibit debt settlement firms from collecting any fees from consumers until debts are settled, except for a small enrollment fee;
- Prohibit firms from misrepresenting the impact of the settlement process on the creditworthiness of consumers;
- Place a cap on back-end settlement fees, based on the settlement services actually rendered rather than the amount of debt that was forgiven;
- Require that any debt serviced by a settlement firm be settled within 12 months.
- Limit agencies allowed to engage in debt settlement practices to nonprofits.
I hope the debt settlement industry listens to the recommendations offered by this expert witness. It is clear that the opinion of experts, including my own, and regulators is that the debt settlement industry needs to operate under a uniform set of rules and regulations that will allow debt settlement companies to exist but ferret out the bad actors that hurt consumers and create a bad reputation for the entire debt settlement industry.
It’s time to take the high road boys.