Can a debt settlement firm charge upfront fees to handle credit card debt?
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If you’ve ever been drowning in credit card debt, it’s likely a debt settlement firm has reached out to you. Even if you haven’t engaged in conspicuous consumption activity, a setback such as a job loss, need for medical services or a car emergency could easily lead to credit card debt piling up.
Debt settlement firms seem to have a nose for smelling out those with piled up credit card debt to offer their services to. Even before you think about whether their services might be effective, you may have to ponder whether to pay them an upfront fee.
What can a debt settlement firm do for you?
Debt settlement firms are businesses that will negotiate with your creditor to “settle” your debt for you. Typically, they will say that they can help you cut down your debt to pennies for each dollar you owe.
On your end, you will likely have to set aside a monthly amount in an escrow account until enough money accumulates for the debt settlement firm to pay off your creditor. They may even tell you to stop making payments to your card issuers or to cease communicating with them directly.
Upfront fees are a no-no
One warning sign to watch for is if a debt settlement firm asks you to pay an upfront fee. The Telemarketing Sales Rule, which goes back to 1995, covers calls that these firms make to prospective customers, either on their own or through a third party.
The Federal Trade Commission amended the rule in 2010 so that it also applies to inbound calls that debt settlement firms, or their representatives, get from prospective customers.
This rule lays out what sort of information a debt settlement firm should provide prospective customers. It specifically forbids these firms from collecting upfront fees before they have successfully settled any of the debt on your behalf. They have to ensure they meet the following conditions:
They should have settled at least one of your debts
You should agree to the terms of any debt settlement they reach with your creditors. Although the agreement with the creditor should be in writing, you could agree to the terms orally. The debt settlement firm cannot get you to pre-approve any settlement they might negotiate in future.
You should have made at least one payment to the creditor, or debt collector, based on the settlement the firm made with it.
If you have credit card debts with multiple issuers and the debt settlement service settles one of them for you, it can only charge a fee proportional to the debt that it settled.
For instance, if you owe three different issuers $2,000 each, and the debt settlement firm’s fee is a total of $1,000, it can only charge you $333.30 after it has settled your debt with one of the issuers, or a third of the total fee for settling a third of your debt.
If you agree that the firm will charge you a percentage of the amount of money it saved you on the debt, it should charge the same percentage for each debt it settles.
For instance, in the above example, if the firm charges you 30 percent of the settled debt and negotiates your payment down to $1500 with one of the issuers, it can charge you 30 percent of the $500 it saved you, or $150. And it should charge you the same base percentage for each debt it settles after that.
Debt settlement firms should also disclose to you upfront how long it will take them to successfully negotiate your debt down, how much it will cost you, any negative fallouts (for your credit report, for instance) and information about any accounts you may have to set up to tackle the issue. They also are forbidden from making untrue claims.
Debt settlement firms may resort to workarounds
In a bid to get around the FTC’s ban on upfront fees, it seems debt settlement firms have resorted to workarounds. They might affiliate themselves with attorneys to whom the upfront fee ban does not apply, for instance. You might think you are engaging the services of an attorney to take care of your debt, but that’s not the case and they only serve as a front for the debt settlement firm.
Attorneys are also not typically subject to state laws regulating debt settlement firms. It seems various states have gotten savvy to this sort of front, though, and brought lawsuits against such firms, according to the Center for Responsible Lending.
It seems debt settlement firms might even try to lure prospective clients into their offices for a face-to-face meeting so that they are not covered by the Telemarketing Sales Rule. Another tactic is to use the Internet to find clients, although any resulting phone conversation would subject these interactions to the rule.
The bottom line
If you are contemplating using the services of a debt settlement firm, be aware that they cannot charge you upfront fees. You might find that you can negotiate with your creditor yourself, or go through an accredited credit counseling firm that could even help you set up a debt management plan.
You could also consolidate all your debt into a lower interest rate loan and slowly pay it off. Another option is to sign up for a balance transfer credit card, depending on how much you owe and whether you can qualify. If you avoid making your debt payments, there will be consequences for your credit score.
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