You’ve probably heard the advertisements on urban radio urging consumers with at least $10,000 in debt to call a number right away for a financial rescue. Promising to end debt troubles by getting creditors to somehow accept less money than what is owed can sound really appealing. In reality, however, consumers mired in debt may often find debt settlement programs to be costly, misleading, and far less helpful than the radio ad promises.
In the newest chapter in the research series titled The State of Lending, the Center for Responsible Lending (CRL) finds that debt settlement is a risky strategy that can leave consumers more financially vulnerable and still laden with debt years after they enroll in such programs.
Regardless of how well consumers follow the instructions of their debt settlement firm, they may ultimately be unsuccessful because many creditors simply refuse to deal with debt settlement companies.
According to the report, “Debt settlement companies do not tell consumers whether creditors will work with their firms at the time of enrollment. However, even if debt-settlement companies were required to disclose whether a particular creditor routinely works with their firm, this provides no real guarantee. In many cases, the party who owns a debt changes over time, since a debt may be sold successively to multiple parties.”
Available data suggests that at least two-thirds of debts must be settled in order to achieve a net positive outcome from debt settlement. Even more debts must be settled for the consumer to achieve real savings if they end up being liable for taxes on the debt reduction.
In the end, many consumers never realize that kind of experience. Rather, they end up worse off financially. According to the American Fair Credit Council, an industry trade association, consumers must typically be enrolled in debt settlement plan for three to four years in order to complete the program. During this time, debt balances grow an average 20 percent while consumers wait for settlements to be reached. Additionally, their credit scores are negatively affected, financial instability increased, and the likelihood of creditor lawsuits loom near.
According to Leslie Parrish, co-author of the report and deputy research director at CRL, “When a consumer stops making payments on a debt, not only is she/he vulnerable to fees and an increased interest rate, the reporting of this delinquency to credit bureaus can impact credit scores for years.”
In general, the higher a consumer’s credit score is, the lower the cost of credit they will incur. Conversely, the lower one’s credit score, the higher the cost of credit and interest will be. Whether applying for a credit card, auto loan or a mortgage, bad credit histories make future credit and borrowing more expensive.
In 2010, the Federal Trade Commission (FTC) issued regulation that barred debt settlement companies from charging fees until they reached settlements with the client’s creditors. While this regulation has stopped some of the most egregious industry practices, CRL’s report finds that significant financial risks remain for debt settlement clients.
Today, the Consumer Financial Protection Bureau shares regulatory oversight of debt settlement with the FTC. Thus far, CFPB has taken multiple enforcement actions against several debt-settlement companies and one payment processor.
CRL also sees a role for states to establish meaningful limits of debt settlement fees. One recommendation is to limit the fees that can be charged and to calculate such fees on the basis of the amount of savings achieved for the consumer.
State and federal regulators could also require better screening of prospective customers to lower the risk of a bad outcome. Factors such as the amount of debt to be enrolled, creditors and the consumer’s financial circumstances would be taken into account. Additional recommendations can be found in the report located at this link.
Ellen Harnick, co-author of the report and senior policy counsel at CRL, said, “What’s clear is that more action is necessary to protect consumers.”
Charlene Crowell is a communications manager with the Center for Responsible Lending.