Have thousands of dollars of credit card debt and little money? The online ads for debt settlement might seem the answer to your troubles.
They promise to settle your debt with creditors for 30 cents or 50 cents on the dollar. No damaging bankruptcy. You can be debt-free in one to three years.
But there's a lot those ads don't tell you.
Debt settlers can charge stiff fees. Creditors could refuse to settle. They might keep hounding you with calls or take you to court. You can get hit by taxes on debt that's forgiven. Sometimes you can end up worse off.
For years, lawyers have done debt settlements for clients on the verge of bankruptcy. But in recent years, as credit card debt has mounted, the number of for-profit companies offering debt settlement has exploded.
The Association of Settlement Companies estimates that the number of debt settlers has doubled in the past two years, to as many as 1,000. The Federal Trade Commission recently announced that it will hold a one-day workshop in September to examine the growing industry and consumer protections.
This growth is not necessarily good news.
"Debt settlement has so many bad apples, it gives the entire industry one big black eye," says John Ulzheimer, president of consumer education for Credit.com.
There's a lot of confusion about debt settlement. That might be the reason that some consumers choose this method of eliminating debt instead of others that are less risky and less damaging to their credit records.
Debt settlers try to negotiate with a creditor to accept a lump sum payment that's less than what you owe. Before they can do that, you generally must make monthly payments to the debt settler or another company to build up a pot of money to offer creditors. Some debt settlers advise that you stop repaying debts and communicating with creditors.
"That's potentially disastrous advice," says FTC staff attorney Sara Gottovi.
Avoiding creditors won't stop interest and penalties from accruing. Collection calls could continue.
Fees are all over the map, too. You might pay a fee upfront, monthly payments or a percentage, say 20 percent, of the debt that's forgiven.
There is no guarantee of how long the process will take, how much you will save or even whether your creditor will accept a settlement. You can end up paying for nothing.
That happened to Sara Raimo of Elkridge.
The 30-year-old says she went to a debt settler four years ago after a prospective employer checked her credit report and suggested that she reduce her $5,000 credit card debt. She signed up with a Nevada debt-settlement company that advertised on billboards and online. The company charged her about $300 for each of her three credit cards. It also withdrew about $250 a month from her bank account to build up settlement money.
After six months, the company told her it had eliminated one of her card debts. But as time went on, Raimo says, she had trouble contacting the company because it kept moving. When she went online to find it, she found a blog where hundreds of consumers complained about the company.
She called her credit card companies and learned that all three debts were still outstanding and that the combined balances had ballooned to $18,000.
Raimo figures she paid $4,000 to the debt settler, money she hasn't gotten back. She negotiated a settlement herself. One credit card issuer accepted 60 cents on the dollar; the other two demanded full payment. Raimo dipped into her 401(k) to pay them off.
Despite the experience, Raimo says, she likes the concept of debt settlement. She just wants stricter laws regulating debt settlers.
The FTC has taken action against debt settlers for deceptive practices, but oversight by states varies. David Leuthold, vice president of the Association of Settlement Companies, says the trade group favors regulation as long as it's uniform and not onerous.
This year, Maryland legislators failed to pass legislation that would have required debt-settlement companies to be licensed and limited the amount they can charge for services.
Maryland's attorney general received 21 complaints about debt settlement last year, the majority of them involving Maryland lawyer Richard A. Brennan and his office manager, Jeffrey Formulak. Both are former employees of AmeriDebt, the defunct credit counselor that was sued by the FTC and several states for charging consumers high, hidden fees.
State regulators accused Brennan and Formulak of deceptive practices, overstating the amount consumers could save in debt settlement and using at least $240,000 set aside for clients' creditors to pay the debts and expenses of Brennan's law firm. The pair settled with the state in October without admitting wrongdoing, but the state says they have breached the agreement.
Brennan said the state's allegations last year were false and that he settled to avoid a drawn-out, costly dispute. He maintains that he has honored the settlement.
Formulak could not be reached for comment.
If you're over your head in debt, various steps can be taken without resorting to debt settlement.
Start by seeking budgeting advice from a nonprofit credit counselor, suggests the FTC's Gottovi.
Contact your creditors. They might be able to work out a repayment plan for you.
Consider a debt-management plan offered by a reputable nonprofit credit-counseling agency, which can negotiate with creditors to reduce your interest and waive penalties. In turn, you make a single monthly payment to the agency, which disburses the money to your creditors. (Unlike debt settlers, groups offering debt management to Marylanders must be licensed by the state, and the fees they can charge are limited.)
A debt-management program can last up to five years. It won't affect your credit score, although creditors aren't likely to extend new credit to you during your enrollment, Ulzheimer says.
Debt settlement will remain on your credit report for seven years, and you'll end up paying higher interest rates during that time, he says. A Chapter 7 bankruptcy remains on your record for 10 years.
If you still decide that debt settlement is for you, avoid companies hawking promises online.
"Our advice is that unless a consumer is working with a qualified attorney, they should avoid it," says Travis Plunkett, legislative director of the Consumer Federation of America.