Feds strengthen debt settlement rules

When faced with overwhelming debt, many people don't know where to turn: Should they file for bankruptcy, consolidate their debts into one loan or try to settle with creditors for less than they owe? Each approach can be fraught with difficulties and expense if you don't know what you're doing, but inaction is probably the worst course.

If you're considering debt settlement, be aware that the Federal Trade Commission (FTC) recently changed several key rules governing how for-profit debt settlement (a.k.a. "debt relief") companies may bill for their services and what information they are required to disclose.

Briefly, debt settlement is where you negotiate with creditors to accept less than the full amount you owe. You can conduct these negotiations yourself, but some people hire a debt settlement company to act on their behalf. There's usually a hefty fee – 15 percent or more of the negotiated settlement is common.

In a typical contract, you might be asked to stop making payments on unsecured debts, such as credit cards or medical bills, and instead put the money into a dedicated savings account. Once you've accrued sufficient funds, the settlement company attempts to negotiate with your creditors to accept lump-sum payments for less than the amounts owed.

Although many legitimate debt settlement companies exist, the FTC found that a number of businesses were targeting consumers in financial distress by making unrealistic claims, such as promising to reduce debt by as much as 60 percent with no damage to their credit score – in exchange for a large up-front fee.

Unfortunately, the FTC estimates that approximately two-thirds of these consumers are unable to accumulate enough savings for a sufficient settlement offer and therefore not only forfeit the fee, but still owe their debt, plus accumulated interest and additional penalties.

Effective October 27, 2010, certain for-profit debt settlement, debt negotiation and credit counseling companies can no longer collect fees for their services until they have renegotiated, reduced or settled at least one outstanding debt and the client has made at least one payment under the new agreement.

Other conditions of the new regulations include:

• They apply only to companies that market their services by telephone or take phone calls from customers responding to print, broadcast or other ads.
• They do not cover nonprofit firms, but do apply to companies that falsely claim nonprofit status.
• They don't apply to in-person only or Internet-only sales.
• Although settlement companies can still require you to set aside savings in a dedicated account to pay creditors (and their own fees), you retain control over the account, earn interest on its balance and may withdraw the funds at any time without penalty.
• Companies must disclose how long it will take to see results, how much their services will cost, negative consequences of using debt relief services and key information about dedicated savings accounts, if they require one.
• The rules do not limit the amount of fees, only when they may be charged.

Before settling on how to manage your debt, you may want to speak to a certified credit counselor. The National Foundation for Credit Counseling provides referrals to free and low-cost non-profit credit counseling (www.nfcc.org).