Americans are burdened with more credit card debt than ever, so it's no surprise they're turning to companies who promise to help reduce debts -- for a fee.
Early Show financial contributor Vera Gibbons shared some warnings about using those companies on the show Tuesday.
The companies' ads are plastered across TV and radio, offering to "cut your debt in half" and other fantastic-sounding promises. While the commercials sound enticing, many consumers are hurt by the providers' shady practices, Gibbons observed.
"In the past, home equity or year-end bonuses could be used to help pay off debt," she said. "But those options have disappeared, along with the ability to easily obtain a loan or additional credit cards. This makes many people struggling with bills prime targets for debt settlement companies."
The number of such companies has increased dramatically over the past couple of years. Unfortunately, the number of complaints against them has grown, as well: The Federal Trade Commission says gripes more than quadrupled between 2006 and 2007. State attorneys general report being flooded with complaints, too.
In North Carolina, complaints doubled last year, while in Florida they tripled, spokespeople for the state attorneys general said. And in New York last week, Attorney General Andrew Cuomo launched an investigation into the companies, subpoenaing 14 from across the country and one law firm.
"Today, millions of hardworking Americans are finding themselves imprisoned by debt. In response, a rogue industry has stepped in, offering consumers false hope, charging tremendous fees, and leaving them in a worse financial situation," Cuomo says.
Other consumer advocates agree that these companies are bad news. And most of them have an "F" rating from the Better Business Bureau.
What are debt settlement companies offering, and why are many of them so bad?
In general, Gibbons said, the companies agree to contact your creditors and negotiate reduced balances.
Sounds good so far, right?
Gibbons explained where the trouble begins:
But consumer advocates warn that a majority of the companies can't or won't deliver on their promises to reduce your debt. The National Foundation for Credit Counseling recently explained that, "A settlement company may suggest that you stop paying your creditors and instead begin making deposits into a special third-party account. The settlement company will attempt to negotiate a settlement offer with your creditor once enough money relative to the debt is on deposit. This may take six months or more, although the exact length of time will vary with circumstances. During this time, the balance on your debt can continue to grow if interest and various penalty fees continue to be charged by your creditor. As a result, you may owe more than when you started and your credit may suffer."
Even worse, there have been many instances where none of this money ever makes it to creditors -- the companies simply steal it, Gibbons points out. Plus, a growing number of credit card companies refuse to work with debt settlement groups. Of course, a group probably won't tell you that until after you've paid them.
Until the government begins to regulate these companies, your best bet is to stay away from them, Gibbons suggests.
"While there are some legitimate companies out there that will do what they claim, that doesn't erase the other negatives -- big fees, taxes, hurting credit report," she said.
Experts say working with these companies is only one step above bankruptcy, and should be avoided at all costs. But where does that leave you? Where else can you turn?
"Start by trying to negotiate with creditors yourself," Gibbons said. "While they likely won't forgive any of your debt, they may lower your interest rate, or eliminate some fees. Don't just roll your eyes and say, 'Yeah, I've heard that before.'"
Gibbons added, " ... Just recently, the top 10 credit card issuers agreed to make more concessions for consumers in financial trouble and initial reports are that individuals are having more luck working with creditors. If you can't make a big enough dent in your debt yourself, look for a credit counseling agency. Again, you need to choose a legit company, but there a lot of good companies out there as compared to debt settlement companies. For a nominal fee - less than $100, and often closer to $20 -- a credit counselor will look over your finances and provide some basic financial advice and education."
She added that a credit counselor can also negotiate lower interest rates with creditors and get them to remove fees from your account. A credit counseling company can enroll you in a "debt management plan." Under this plan, you give a lump sum to the company each month and they dole out payments to your various creditors at reduced interest rates.
"You still need to do your due diligence in choosing a credit counseling company," Gibbons said. "Most of them are non-profits, but that doesn't make them legit!"
Gibbons suggests checking with your local Better Business Bureau and state attorney general's office to see if there have been any complaints lodged against your credit counseling company. Gibbons noted that reputable firms will be affiliated with the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies.
"And the company should never try to push you immediately into a debt management plan," she said. "If they do, that's a red flag that they may not have your best interest at heart."