New Federal Trade Commission (FTC) rules regulating the debt relief industry took effect one year ago – changes that included the well-known advance-fee ban, prohibiting debt relief companies from collecting any fees until after a result has been negotiated for and accepted by a customer. Because of these FTC rules, the entire industry has changed – and continues to evolve – dramatically. In fact, combined with an uncertain economy, fears of another recession, and rising consumer debt, the industry is experiencing the most rapidly changing business environment in its short history.
Consumer debt is not going away. The latest statistics on U.S. debt, issued in July by the Federal Reserve, show that Americans owe $2.45 trillion in consumer debt – the highest level since 2008. Of that amount, $792.5 billion is revolving debt – and although significantly lower than its peak of $972.2 billion in August 2008, it is still an enormous number. Recent data also has shown that the average American who carries credit card debt has a balance of nearly $15,000. While this figure is down slightly from the previous quarter, the fact remains that many Americans are in serious debt hardship and, in many cases, must look to obtain help in resolving that debt.
The FTC rules seek to protect those very consumers from predatory businesses looking to take advantage of them. This is considered a major step in the right direction. Over the past year, the regulations have made it easier to distinguish companies that get results for their clients from those that don’t. This result helps consumers as well as benefits the entire debt settlement industry. It levels the playing field. In addition, the regulations are an asset for the creditors with whom the industry negotiates by allowing consumers to accumulate funds more quickly in order to resolve their debts.
Pre-FTC Industry Evolution
In order to understand the impact of the rules on the industry and on consumers today, it is helpful to understand the climate – and problems – that led to the changes.
The debt settlement industry initially formed out of an unmet need of consumers struggling with debt. These consumers who have turned to debt settlement come from all economic strata. All, however, share two common characteristics: they suffer from unmanageable levels of consumer debt, primarily credit card debt; and they have few, if any, debt resolution alternatives available to them.
Unlike consumers with stable financial foundations, the typical debt settlement client either does not own a home, or cannot refinance his or her home due to lack of equity. The client also generally has a high debt-to-income ratio and a severely damaged credit score. For this most distressed consumer constituency, making minimum monthly payments, or paying their bills through a debt management program, which typically provides only modest monthly payment relief, has been out of reach. This has historically left bankruptcy as the only alternative for many.
While some mom-and-pop operations began offering debt settlement services as early as the 1990s, it was not until the early 2000s that the industry took off. As the economy sputtered in the wake of the dot-com crash, and as consumer debt exploded, the number of firms selling or providing debt settlement services began to grow dramatically. Then, three significant catalysts unfolded, leading to an explosion in the industry:
- Many non-profit credit counseling companies began facing regulatory problems, in part due to misuse of their non-profit status.
- The 2005 bankruptcy reform made it more difficult and expensive for consumers to qualify for bankruptcy (in particular, Chapter 7).
- The mortgage market imploded, making it next to impossible for a consumer to use home equity as a way to pay down credit card debt.
This led to a significant decline in options available to consumers, and the gap was filled in by debt settlement companies. The industry grew from a dozen participants in 2002 to more than 1,000 firms by 2009. This rapid growth, not unexpectedly, had consequences. The practice of charging monthly fees before debts were actually resolved worked relatively well when the industry was in its nascent stage: a small number of companies, most of which took pride in their work, and maintained a strong focus on customer results. But the extraordinarily low barrier to entry and the ability to charge upfront fees led to an influx of competitors who did not share the same commitment to customer results as did the industry’s early participants.
Ultimately, consumers could not tell a good results-oriented company from a less-scrupulous one because all of the marketing claims, websites and advertisements looked the same. Many consumers signed up with companies whose results did not back up their claims. Creditors and collectors became frustrated with the industry because so many companies were collecting significant upfront fees from their clients and leaving little money for actual resolution of debts. The good players in the debt settlement industry suffered as the entire industry began to be painted with the same negative brush.
The New Regulations
Against that landscape came increased regulation at the state level, and finally, federal regulation in the form of the FTC’s debt relief amendments to the Telemarketing Sales Rule. In summary, the new rules, which the FTC details at http://www.ftc.gov/opa/2010/07/tsr.shtm, seek to protect consumers with these key provisions:
- Debt relief providers must accurately represent the results consumers can expect to achieve.
- Debt relief providers must make specific disclosures.
- Debt relief providers cannot charge any fees whatsoever before negotiating a resolution on a customer’s credit card or other unsecured debt. Specifically, companies cannot collect fees for debt relief services until the debt relief service successfully renegotiates, settles, reduces, or otherwise changes the terms of at least one of the consumer’s debts. Furthermore, the customer must approve the negotiated resolution before any fee can be charged.
For debt relief businesses, this advance-fee ban has had serious consequences. Since most of these companies relied on monthly or upfront fees to cover the cost of acquiring new customers and running their businesses, the delay in cash flow has had a significant impact.