Debt Settlement Programs Increase Financial Risks to Vulnerable Consumers

New report suggests recent regulations are insufficient to curb the financially damaging effects of debt settlement


Center for Responsible Lending
June 30, 2014

A new report from the Center for Responsible Lending (CRL) finds that the debt settlement remains a risky strategy for debt reduction – and often leaves consumers more financially vulnerable.

Debt settlement companies offer the promise of settling a consumer’s debt for a fraction of what they owe. The idea is simple: debt settlement companies offer to negotiate down the outstanding debt (usually from credit cards) owed to a more manageable amount so that a consumer can become debt free. Unfortunately debt settlement carries significant risks that may result in consumers becoming even worse off.

Debt settlement is inherently a risky venture: in order to enroll into debt settlement programs, consumers are required to default on their debt which often results in fees, increased interest rates, and sometimes even lawsuits from creditors. Even after assuming all this risk, consumers are offered no guarantees; in fact, some creditors refuse to negotiate with debt settlement companies at all. Even if a settlement is reached, a consumer unable to keep up with the new settlement arrangement risks falling back into default – and now without the fees paid to the debt settlement company for negotiating the agreement. CRL finds that consumers must settle at least two-thirds of the debt they enroll in a debt settlement program to benefit, a result that many will not achieve.

“The implications of defaulting on debt are not to be taken lightly,” said Leslie Parrish, co-author of the report and deputy research director at CRL. “When a consumer stops making payments on a debt, not only is she vulnerable to fees and an increased interest rate, the reporting of this delinquency to credit bureaus can impact her credit score for years; she also may be sued by her creditor.”
After defaulting on their debt, a consumer’s debt usually grows substantially—about 20% on average–while enrolled in a debt settlement program. This increasing debt balance, combined with debt settlement fees and potential tax liability, can substantially reduce any realized savings. In fact, CRL finds that consumers must settle at least two-thirds of their debt to benefit, and available data suggest that many are unable to achieve this result.

In response to concerns about debt settlement, the Federal Trade Commission (FTC) issued a regulation in 2010 that barred debt settlement companies from charging fees unless they reached settlements with the client’s creditors. . Unfortunately, this report finds that significant risks remain for debt settlement clients even after this important reform.

“What’s clear is that more action is necessary to protect consumers,” said Ellen Harnick, co-author of the report and senior policy counsel at CRL.

The report recommends the following:

  • States that currently do not allow debt settlement should not authorize the practice until the industry can demonstrate a significant majority of consumers benefit and risks are minimized.
  • Debt settlement companies be required to ensure that debt settlement is appropriate for their clients. This can include screening clients before enrollment to gauge their financial status and including a “not worse off” provision to make sure debt settlement doesn’t further aggravate financial vulnerability.
  • All debt settlement companies must be required to adhere by the same set of rules to ensure that no fees are charged until settlements are negotiated.

The report is the newest installment in CRL’s ongoing series of reports, The State of Lending in America and Its Impact on US Households. State of Lending offers an across-the-board survey of financial products that Americans use in everyday transactions, buy homes and automobiles, and build savings and wealth.

Contact: Catherine An, 202-349-1878 or catherine.an@responsiblelending.org

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About the Center for Responsible Lending

The Center for Responsible Lending is a nonprofit, nonpartisan research and policy organization dedicated to protecting homeownership and family wealth by working to eliminate abusive financial practices. CRL is affiliated with Self-Help, one of the nation's largest community development financial institutions.