NCPA - National Center for Policy Analysis


March 24, 2008

Like credit counselors, debt-settlement firms generally collect a single monthly payment from clients.  But rather than disbursing the money to credit-card companies to cover the borrowers' bills, they withhold it.  The settlement firms then use the money as a bargaining chip in an attempt to negotiate a lump-sum payout with lenders.

The booming business has caught the attention of prosecutors and regulators, who say such programs can leave consumers in worse financial shape.  When banks don't agree to settle -- if the settlement firm contacts them at all -- consumers get hit with late charges and are penalized with higher interest rates, leaving them with even more debt than when they started.

Wary of such pitfalls, seven states have already banned settlement activities.  Meanwhile, the Federal Trade Commission and attorneys general in six states have recently filed complaints against debt-settlement firms:

  • Fees can run as high as 30 percent of the total outstanding balance, or $3,000 on $10,000 in debt.
  • The bulk of their initial payments -- those made within the first year -- go toward fees rather than the settlement.

Although some consumers have found relief with debt-settlement firms, the programs do not have the same success rate as credit-counseling agencies:

  • Credit counselors, which have long-standing relationships with issuers, work with lenders to lower interest rates and create a monthly payment plan for borrowers.
  • According to the National Foundation for Credit Counseling, which represents 1,500 counselors in the United States, 60 percent of clients complete the plans.

By comparison:

  • North Carolina prosecutor Philip Lehman estimates that 80 percent of consumers drop out of debt-settlement programs within the first year.
  • And the Federal Trade Commission found that at one firm, just 1.4 percent of the consumers who entered the program finished it and settled with lenders.

Source: Robert Berner and Jessica Sliver-Greenburg, "Look Out For That Lifeline," Business Week, March 17, 2008.

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