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New rules could cripple debt-settlement industry

In a victory for consumers, this October it's going to be a lot tougher to be in the debt-settlement business.

By Stacy Johnson Jul 30, 2010 2:51PM

This post comes from Stacy Johnson at partner site Money Talks News.


Unless you've been living in a cave for the last several years, you've seen and heard debt-settlement ads -- the ones that make it appear that eliminating credit card debt is as simple as paying "pennies on the dollar."


But after October, those ads may start fading away, along with many of the companies. The Federal Trade Commission has announced what could become crippling restrictions on this particular way to deal with consumer debt.


We've done several articles on the problems surrounding debt settlement -- the process of offering a creditor (typically a credit card company) less than the full amount owed to satisfy a debt. The new FTC restrictions are designed to address consumer complaints regarding companies making promises they didn't keep and charging high up-front fees for services they ultimately didn't provide.

New rules taking affect in October will prohibit a common debt-settlement practice -- charging an up-front fee prior to fully eliminating a customer's debt. The new rules also require disclosure of how long the settlement process could take, what it costs and the potential damage that could result to a consumer's credit history. (See "Should I consider debt settlement?") The rules, which will apply only to for-profit debt-settlement companies, also require that the companies set up dedicated accounts for payments they collect and hold for consumers.


In a press release announcing the new regulations, FTC Chairman Jon Leibowitz said, "Too many of these companies pick the last dollar out of consumers' pockets and, far from leaving them better off, push them deeper into debt, even bankruptcy."


He added, "This rule will stop companies who offer consumers false promises of reducing credit card debts by half or more in exchange for large, up-front fees."


Debt settlement has been a burgeoning business as the recession, unemployment and the housing bust resulted in millions of Americans with monthly debt payments they couldn't meet. These companies offer a seemingly simple and attractive solution by advertising that they can settle debts for a fraction of what's owed.

The process of debt settlement often requires a consumer to set aside money in an account for many months -- even years -- until enough is collected to offer a credit card company a lump-sum settlement. Because many debt-settlement companies will no longer be able to collect any fees until the end of the process, that could put many out of business.


But don't expect all the Internet ads you see regarding debt settlement to go away. The new rules cover calls made from consumers in response to debt-settlement ads, as well as telemarketing calls. The rules don't apply, however, to transactions that take place face-to-face or entirely online.


Because consumers can often confuse legitimate credit counseling organizations with unsavory debt-settlement companies, my advice -- after October, at least -- is to weed out debt-settlement companies by getting on the phone with any company offering to help you reduce your debt burden.  And always ask about up-front fees.


In addition to the FTC crackdown, two bills are pending in Congress that would radically limit the fees companies can charge. Current fee structures are commonly 10% of the amount of debt negotiated. The new legislation would limit them to a maximum one-time fee of $50 plus 5% of the settlement savings.


More from Money Talks News and MSN Money:

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