This article was coauthored by Ji Won Kim.
The recent economic crisis has placed numerous Americans in vulnerable positions and consumer debt has risen to historic levels. As a result, deep concerns have arisen about the rapidly growing debt settlement services industry, particularly the industry's pervasive practice of taking advantage of desperate consumers' fears and financial troubles.
Debt settlement companies claim that they will negotiate with consumers' creditors to drastically cut down their debts and lift them out of despair. In reality, however, enrolling in a debt settlement service often leaves consumers owing more than before, facing bankruptcy, and with ruined credit scores. These flawed practices are even more damaging to people on the lower rungs of the economic ladder, which are the very people that debt settlement services target. The National Consumer Law Center reports that certain companies work only with "insolvent customers."
The Government Accountability Office's (GAO's) recent investigation of the debt settlement industry revealed the appalling situations consumers face. The GAO posed as fictitious customers and approached 20 companies across America. Seventeen of the companies said they collect upfront fees, and nearly all of them advised consumers to stop paying their creditors. Furthermore, some companies engaged in fraudulent practices such as claiming high success rates--despite the fact that the Federal Trade Commission (FTC) found that less than 10 percent of consumers successfully complete debt settlement programs.
Many states across the country are taking action against debt settlement services that trick vulnerable consumers into unfair arrangements. Some states have implemented their own laws in response to the lack of federal initiative. Virginia enacted legislation that provides detailed requirements for debt settlement operations, and Arkansas and Wyoming chose to prohibit for-profit debt settlement companies in their states altogether.
Illinois has recently joined the ranks of other forward-minded states by passing the Debt Settlement Consumer Protection Act (Public Act 96-1420) this summer. The new law requires a written contract that clearly indicates the terms of the debt settlement agreement and that must be signed by both the service provider and the customer. Most importantly, the new law caps the initial fee to $50 and forbids debt settlement companies from unfairly charging customers without having done any work. The settlement fee is capped at 15% of the savings and cannot be charged until the creditor has entered into a legally enforceable agreement with the consumer. Also, debt settlement service providers must warn consumers that debt settlement service is not suited for everyone and that it may have detrimental effects on the consumer's credit history and credit score. Finally, companies must provide detailed accounting reports, and consumers are entitled to cancel the contract and receive a refund. The Illinois Department of Financial and Professional Regulation has accepted public comments on proposed rules implementing the law and is expected to announce the final rule within the next few months.
In addition to the independent state efforts, 41 state attorneys general teamed up to support the FTC's new rule governing the debt relief industry. In July 2010, the FTC announced the final Telemarketing Sales Rule.The new rule includes important provisions that ban advance fees, require disclosures, and prohibit misrepresentations. The advance fee ban provision will go into effect on October 27, 2010, and all other provisions went into effect last week on September 27, 2010.
While the new FTC regulation covers calls consumers make to the debt relief service firms in response to their advertising, it unfortunately does not cover in-person or internet-only sales of debt settlement services. Therefore, more federal measures are necessary, including passage of the Debt Settlement Protection Act (H.R. 5387 and S. 3264). It is time for more action in Washington to save countless American consumers from suffering from consumer debt settlement companies.