Wouldn't you like to get something for nothing? That sounds too good to be true, but it's the business model the debt settlement industry has regularly used as it has taken money from tens of thousands of vulnerable consumers around the country and often done little or nothing to help them settle their debts. To stop such predatory practices, the Maryland legislature needs to strengthen the debt settlement bills now before the House and Senate and establish firm and reasonable caps on the fees the industry can charge consumers.
The debt settlement business has grown rapidly during tough times in tandem with rising consumer debt, stagnant wages and rising costs of living. Many individuals — caught between the rising costs for health care, food and utilities and paychecks that don't meet those needs — resorted to using credit as a "plastic safety net." The same households often went deeper into debt to pay for a major home or car repair or to make ends meet during a period of unemployment.
Many of these families turned to debt settlement firms to reduce their debts. Such firms typically encourage consumers to stop paying their debts and to pay instead into an account the company is supposed to use to negotiate a lump-sum settlement with creditors. As their bills go unpaid, consumers continue to receive calls from collection agents, see their credit scores plummet and often end up bankrupt. Meanwhile the debt settlement firms, who until recently often collected their fees in advance, continue to profit, even if they have often done nothing to help families in need.
Such business practices have drawn the ire of federal and state regulators as well as the Better Business Bureau. Forty-one state Attorneys General noted problems with the industry, including failure to perform, deceptive practices, misrepresentation of savings and more. Twenty-one states have brought 128 enforcement actions against 84 debt settlement companies. In light of these complaints, the Federal Trade Commission has ruled that debt settlement firms can no longer collect fees until after they settle a consumer's debt. Seven states have banned debt settlement companies from operating altogether.
Maryland consumers have had their share of bad experiences with debt settlement firms. Since 2007, the number of complaints to the Maryland Attorney General's office has risen 144 percent. From April to December 2010 alone, the Attorney General's office received 88 complaints about debt settlement firms from Marylanders. These consumers lost more than $112,000 to the industry.
Yet Maryland, home to many debt settlement firms, is seeking to regulate rather than ban the industry. Unfortunately, as a result of pressure from industry lobbyists, the bills now before the House and Senate would allow the industry to charge fees that would very likely wipe out any savings consumers achieve and leave in place a system that gives settlement firms a strong incentive to enroll debts they will never be able to settle.
The House legislation would cap debt settlement fees at either 30 percent of the amount firms actually save consumers or 20 percent of the total debt enrolled in the program; the Senate bill would cap fees at 25 percent of debt enrolled.
A savings-based fee cap makes good sense. That model rewards a debt settlement firm for the money it actually saves consumers and encourages the firm to take on only debts that it is confident it can settle. Conversely, the debt-enrolled model provides the same kind of perverse incentives that led to the mortgage meltdown. Just as toxic loans ran rampant, in part, because those who issued the loans often profited whether or not the loans could be repaid, the debt-enrolled model rewards debt settlement firms whether or not they can settle the debts enrolled.
This model gives debt settlers every incentive to enroll as many debts as possible (even if they know certain creditors will not cooperate) to maximize their fees. Still worse, it creates incentives for the settlement firms to make quick and poorly negotiated settlements, since they will get the same fee regardless the quality of the settlement they win for consumers.
The debt settlement legislation now moving forward would give a veneer of respectability to an industry riddled with complaints while reinforcing a fee scheme that rewards poor performance. It is worse than doing nothing.
Maryland families shouldn't have to wait for real protection from predatory debt relief companies. But unless the legislation can be amended to limit to consumers real protection, we need to kill these bills and try again next year.
Marceline White is executive director of the Maryland Consumer Rights Coalition and a member of the working group that prepared the "Debt Settlement Services Study" for the Maryland legislature this year. Her email is firstname.lastname@example.org.