Can you imagine getting a job at which your boss tells you that you'll get your paycheck every two weeks whether or not you show up? And performance doesn't matter. Everything's fine as long as you merely say say you'll do the work.
Most of us would laugh at such a preposterous idea -- or ask where we could sign up. But this scenario is business-as-usual at so-called debt settlement companies -- the ones that advertise during late-night television and on urban radio. In California, hundreds of these companies get paid every year by desperate consumers for simply claiming they will reduce or eliminate the consumers' burdensome debts. They make no guarantees, but they make lots of money.
The nation has been rightly fixated on managing the housing-related debt of millions of Americans trapped in unaffordable mortgages. At the same time, however, unsecured debts such as credit card purchases, medical bills and student loans have brought many Americans to the brink of financial ruin. As a result, more and more companies with flashy advertising and captivating promises to eliminate consumer debt for pennies on the dollar have entered the fray.
Typically, consumers pay these debt settlement companies hefty "setup" fees of thousands of dollars, plus hundreds of dollars more in monthly fees, totaling at least 15% to 20% of the debt, whether or not any debt is settled with the creditors. The companies instruct clients not to pay their bills, not to speak to their creditors and instead begin setting aside large sums of money -- for example, $400 per month on a typical debt load of $24,000 -- presumably to pay creditors when settlements have been reached.
But the math doesn't add up. The consumer will have saved $2,000 at the end of five months. Most of this will be eaten up after the company deducts the setup fees ($1,200 for the first three months) and two months of monthly fees ($480), for a total of $1,680. Just $320 is left to settle the debt, which still amounts to $24,000, and probably more, with the addition of interest and fees that accumulated while the consumer was following instructions to not pay the bills.
This makes it nearly impossible for debt settlement companies to deliver on their promises. In fact, the Colorado attorney general's office found that in that state, fewer than 10% of consumers contracting with these companies since 2006 were able to pay off or settle all of their debts. Further, the industry's data report that two-thirds of clients don't settle all of their debts.
It is not surprising that the Federal Trade Commission released proposed debt-settlement rules this summer, concluding that "in the vast majority of cases, consumers are required to pay in advance for services that, in most cases, are never rendered." Not only that, but creditors often escalate collection efforts or initiate lawsuits against consumers when they find out that a debt settlement company is involved, leaving the borrower poorer, deeper in debt and much worse off.
Despite the problems with this industry, AB 350, legislation sponsored by Assemblyman Ted Lieu (D-Torrance) to regulate debt settlement companies, would put the stamp of approval on this abusive model. It would let these companies charge as much as 5% of the debt right off the bat, and total fees of 20% of the debt through additional monthly payments -- whether or not the companies actually settle any debt.
The FTC and 41 state attorneys general -- including California's Jerry Brown -- agree that substantial fees paid in advance of performance by a debt settlement company, like those authorized by the bill, are unjustified and harmful to consumers. This fall Gov. Arnold Schwarzenegger signed a bill banning so-called mortgage modification service providers from collecting fees before providing the services. The similarities are clear: Both types of operations charge consumers excessive fees before services are rendered and with no guarantee of, or incentives for, success.
Although consumers may want to settle their debts, they shouldn't be forced to pay thousands of dollars for a bill of goods. To be sure, AB 350 means well, but doesn't do what's needed. The failure of the bill to crack down on the most abusive and harmful element of debt settlement -- the high upfront fees with no guarantee of success -- means the bill does not do well. Consumers should pay for performance, not promises.
Ginna Green and Caryn Becker are on staff at the California office of the Center for Responsible Lending, a research and policy organization based in North Carolina.