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Damned by Debt Consolidation: Settlement Could be a Trap

Families struggling with overwhelming debt may be tempted to respond to advertisements that promise to settle your bills for pennies on the dollar, but beware. Using a debt settlement company could be a trap that leaves you older and further in debt.

This joint warning came from a coalition of much-lauded consumer groups--including Consumers Union, Consumer Action, the National Consumer Law Center and Consumer Federation of America. They issued a joint press release on Tuesday in an effort to slow the debt-settlement industry's full-tilt push to create a system of state registration that would legitimize the business, which has also come under fire from the Federal Trade Commission.

Debt settlement companies typically suggest that consumers make monthly savings payments into a special account held by the settlement company. That money is supposed to pay off all of the consumer's debts after the settlement company manages to negotiate a cut-rate pay-offs with each lender.

The problem, the consumer groups say, is that the industry is long on promises and short on results and guarantees. Meanwhile, they charge up-front fees that typically range from 14% to 20% of what you owe. Because those fees are taken out of your savings account regardless of whether the settlement company is able to negotiate away your debts--and because late fees and charges are often accumulating on your credit card bills while the settlement company sits on your payments--debt settlement can dramatically worsen the consumer's economic woes.

"The industry's own statistics show that debt settlement doesn't eliminate all of the debt for most consumers," said Gail Hillebrand, financial services campaign manager at Consumers Union in San Francisco. "But the full fee can be deducted from your savings even if you are still stuck with your debts."

Added Linda Sherry, director or the national priorities project at Consumer Action in San Francisco: "Consumers debts increase because of the interest and penalties, and they may end up being hounded by collectors, sued by their creditors, having their wages garnished and left with ruined credit ratings."

A raft of continuing complaints about settlement companies spurred the Federal Trade Commission to propose rules late last year that would bar settlement firms from charging fees until they'd managed to settle the consumer's debts. In the meantime, the debt settlement industry has been working with state legislatures in an effort to get laws passed that would allow them to operate as usual, with only modest regulation monitored on a state-by-state basis.

The consumer groups say this push is dangerous for the indebted. They want national regulation that would give consumers their money back if the settlement company proved unsuccessful.

They also want cash-strapped consumers to know that they already have better options than paying settlement companies. Specifically:

  • Settle solo. If you are unable to pay your bills and sincere about wanting to dig your way out, there is a good chance that you'll be able to settle your debts on your own. Call your creditors and explain your situation, they may be willing to reduce your balance, cut or freeze the interest while you whittle down the balance. They may also be willing to waive late fees and reduce monthly payments.
  • Call a (non-profit) counselor. There are hundreds of non-profit credit counseling agencies around the country that can help you work out a budget or payment plan with your creditors. To find one near you, call one of two national organizations--the National Foundation for Credit Counseling at 1-800-388-2227 or visit their web site, linked here; or the Association of Independent Consumer Credit Counseling Agencies at 1-800-703-8787, or go to their web site, linked here.
  • Consider bankruptcy. It's a last resort, but if you have no way of paying your debts and your creditors are not willing to negotiate, it may be a viable option, particularly if the bulk of your debt is owed to unsecured creditors. (Your home and cars are financed with "secured" loans, which means you lose the house or car, if you can't pay the lender.) If a credit counselor tells you that bankruptcy is your best option, seek legal advice to get the fresh start that bankruptcy can provide.
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