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The Color of Money

New rules for debt-settlement firms help public, but don’t cover everything

By Michelle Singletary
Washington Post / October 12, 2010

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Got debt?

Well, if you do, the government has made it more difficult for unscrupulous or sham debt-settlement companies to make false claims that much of your debt can be easily erased.

Debt-settlement or debt-relief services promise to renegotiate or in some way change what you owe to an unsecured creditor or debt collector.

Law enforcement officials have increasingly been receiving complaints about companies that collected fees but did little if anything to settle people’s debts. The Better Business Bureau said that since the recession it has received thousands of complaints from all 50 states about debt-settlement companies that have driven people deeper into the hole, in some cases causing them to be sued by creditors or even to have wages garnisheed.

New rules require debt-relief companies to make specific disclosures, such as how long it will take to get results, how much the service will cost, and the potential negative consequences.

The firms are prohibited from misrepresenting what they can do for debtors, in particular the percentage of debt that is typically erased.

The new rules specifically cover telemarketers of for-profit debt-relief services, including those offering credit counseling, debt settlement, and debt-negotiation services. Legitimate nonprofit organizations are not covered by the new rules. Companies that falsely claim nonprofit status are subject to the Federal Trade Commission standards, however.

And beginning Oct. 27, it will be illegal for a debt-relief service to charge upfront fees. Companies that sell their services over the phone can’t get paid until they successfully settle or reduce a customer’s debt.

Fees are often based on a percentage of the total amount of debt that you want help with. Let’s say you owe $20,000 on four credit cards. You might be charged 15 percent ($3,000) of the debt you want reduced. Here’s the problem: You would pay the fee regardless of how many of the accounts, if any, are actually settled, according to the Consumer Federation of America.

There are also provisions on how money set aside for a settlement offer is to be handled. Under the new rules, a dedicated account has to be established at an insured financial institution and the money belongs to the client, who can withdraw it at any time without penalty.

These new rules are a great first start, but Congress needs to close some loopholes. The rules don’t limit the amount of fees that companies can charge. There’s just too much room to gouge people.

Furthermore, the rules need to be expanded beyond debt-relief services offered by telephone. Providers who meet face to face with people before signing them up are exempt from most of the new provisions.

Michelle Singletary is a columnist for The Washington Post.