Granville Jones knew he was spending beyond his means after he racked up $90,000 largely in credit-card debt—$10,000 more than his annual income. So last summer the Durham (N.C.) pharmacist turned to the Consumer Law Center for help. The firm told Granville that if he withheld payments from creditors, the CLC would have the leverage to negotiate a lump settlement on his debts and cut his balances by half in five years. So Granville stopped paying his bills and instead handed over a monthly sum to the CLC to cover an eventual settlement with creditors as well as the firm's fees. "When you are financially stressed, you hope for miracles," says the 47-year-old, who was current on his bills before reaching out to the law firm.
The miracle never happened. Instead, Jones gets daily calls from collection agencies. One lender has sued him in county court for the $25,000 it's owed. Frustrated, Jones cancelled the program in January. The CLC agreed to refund the $10,744 he paid, but only after Jones filed a complaint with North Carolina's attorney general in February. "All Consumer Law did was leave me hanging," says Jones. The CLC did not return calls for comment.
Jones' predicament is another by-product of the credit crunch. With individuals of all income brackets struggling to pay their bills, many are seeking help from the hundreds of debt-settlement firms that promise to reduce credit-card balances by as much as 70% over several years.
NO-BARGAIN BARGAINING CHIP
Like credit counselors, debt-settlement firms generally collect a single monthly payment from clients. But rather than disbursing the money to credit-card companies to cover the borrowers' bills, they withhold it. The settlement firms then use the money as a bargaining chip in an attempt to negotiate a lump-sum payout with lenders. These programs have proliferated of late as credit-card debt has soared; the typical U.S. household now has more than $7,000 in outstanding balances, up 45% from five years ago.
The booming business has caught the attention of prosecutors and regulators, who say such programs can leave consumers in worse financial shape. Fees for the services run high. And when banks don't agree to settle—if the settlement firm contacts them at all—consumers get hit with late charges and penalized with higher interest rates, leaving borrowers with even more debt than when they started.
Wary of such pitfalls, seven states have already banned settlement activities. Others, such as Iowa, are considering similar rules. Meanwhile, the Federal Trade Commission and attorneys general in six states have recently filed complaints against debt-settlement firms. Four are investigating Hess Kennedy Chartered, an affiliate of the Consumer Law Center, including AGs in North Carolina and Florida, both of which filed civil charges against the Coral Gables (Fla.) firm for allegedly deceptive practices. "There are more of these firms than we can handle," says Norman Googel, an assistant attorney general in West Virginia, which is investigating 15 settlement firms. "They are truly exploiting a group of consumers already in crisis." Hess Kennedy didn't return calls for comment.
The settlement industry defends its services, asserting that its payment plans can be more affordable than traditional credit counselors and provide consumers an alternative to bankruptcy. "Debt settlement is a boot camp for getting out of debt," says Nicolas de Segonzac, president of the trade group Association of Settlement Cos. Says Jenna Keehnen, executive director of U.S. Organizations for Bankruptcy Alternatives: "In any industry there are bad actors. But for every complaint, there are thousands and thousands of appreciative customers that have gone successfully through the programs."
What many borrowers who sign on don't realize, though, is that fees can run as high as 30% of the total outstanding balance, or $3,000 on $10,000 in debt. It's also often unclear to individuals, say state and federal prosecutors, that the bulk of their initial payments—those made within the first year—go toward fees rather than the settlement. "
The programs typically require financially strapped consumers to pay fees up front, so they make money whether or not any useful services are performed," says Philip Lehman, an assistant attorney general in North Carolina.
Although some consumers have found relief with debt-settlement firms, the programs do not have the same success rate as credit-counseling agencies. Credit counselors, which have long-standing relationships with issuers, work with lenders to lower interest rates and create a monthly payment plan for borrowers. According to the National Foundation for Credit Counseling, which represents 1,500 counselors in the U.S., 60% of clients complete the plans.
By comparison, North Carolina prosecutor Lehman estimates that 80% of consumers drop out of debt-settlement programs within the first year. And the Federal Trade Commission, which has settled six cases against settlement outfits in the past four years, found that at one of those firms, just 1.4% of the consumers who entered the program finished it and settled with lenders.
Why? One reason is that some banks, including Bank of America (BAC) and Discover Financial Services, (DFS) refuse to negotiate with settlement firms. The programs, issuers say, only add to their pile of bad debt since consumers stop payment. "This is one instance where both creditors and debtors are worse off," says a credit-card executive who declined to be named.
Meanwhile, borrowers rack up late fees, over-limit charges, and other penalties for missed payments. Creditors may also pass the debts to collection agencies or sue for damages in court. Those blemishes inflict long-lasting damage on a credit report. All that can leave borrowers not only with more debt, but even worse, can force them into bankruptcy—exactly the situation many were trying to avoid.
Barbara Bautch knows what it's like to be on that slippery slope. Unable to manage the $12,000 tab on two cards, the part-time health-care aide in Silver Bay, Minn., signed up with settlement firm American Financial Services in 2006, forking over $233 a month to the Bakersfield (Calif.) company. After one of the card companies sued, Bautch learned that AFS hadn't contacted either issuer regarding a settlement deal. Between late charges, penalty interest, and attorneys' fees, her debt now stands at $20,000. AFS did not return calls for comment. Says Bautch: "AFS drove me into bankruptcy, and it was no sweat off its back."