Debt settlement[1] programs too often are not the solution they are marketed to be, according to this new CRL research. Debt settlement companies promote their programs as a way for debt-strapped consumers to become debt-free while paying a fraction of what they owe their creditors. However, our research shows that debt settlement program participants may be left in a worse financial position than where they started and, furthermore, have no way to assess their likelihood of success before enrolling in a debt settlement program.

Our analysis found that a client must settle at least two-thirds of her debts enrolled in a debt settlement program to improve her financial position; this finding is based on assumptions that are highly favorable to debt settlement companies and will not apply in many cases. Using less favorable assumptions, we estimates that a client must settle 80% or more of all debts to benefit.

Past investigations of debt settlement firms revealed dismal settlement rates, with only a minority of consumers completing their programs. Federal rule changes in 2010 restricted debt settlement companies from charging up-front fees before settling any debts, with the goal of curbing some of the worst abuses. However, debt settlement companies have not yet publicly released completion rates (or even partial completion rates) of consumers enrolled in the three years since the rule took effect.

In addition to risks from uncertain settlement rates, consumers who enroll in a debt settlement program must default on their debts, exposing them to financial penalties, escalated collection efforts, lawsuits, and credit score declines. In many cases these can outweigh the financial benefits gained from any settled debts. As a result, consumers considering enrolling in a debt settlement program are rolling the dice on whether it will be a good deal for them or leave them worse off.

1. For-profit debt settlement companies claim to offer an alternative mechanism for reducing unsecured consumer debt, most frequently debt from credit cards. "Be debt free in 36 months!!" and "We can reduce your debt load by up to 50 percent!!" are common claims in the industry. Debt settlement companies offer to negotiate reductions in debt balances with a consumer's creditors in exchange for a fee. To do so, however, debt settlement companies require consumers to first default on their debts. Settlement agreements are often structured so that the consumer pays her creditor over a series of installments, although a lump sum settlement payment may also be an option. Once the consumer enters a settlement agreement with her creditor and makes a first payment on a particular debt under the settlement, the debt-settlement company is able to collect the full fee associated with that particular debt. Often, debt settlement companies calculate their fee as a percentage of the debt at the time of enrollment, rather than as a percentage of the savings achieved as a result of the settlement. Debt settlement clients typically need to remain in the program for three to four years in order to settle most or all of their debts.