What is a Debt Settlement Company?

A debt settlement (DS) company is a for-profit business that maintains a consumer’s funds in separate accounts, holding the money until the company believes it can settle the consumer’s debts for less than the full amount owed. Because most DS companies are for-profit businesses, they are not exempted from numerous consumer protection laws that exempt non-profits.

Nearly all companies have a minimum debt requirement. Most DS companies require a minimum amount of debt required for the program. These amounts ranged from $5,000 to $10,000. All DS programs handle unsecured debt only.

The companies have different ways of doing business, but nearly all of them require the consumer to set aside money each month. Sometimes the settlement company will set up an account for the consumer. In other cases, they will ask the consumer to show proof of an account. They will almost always figure out a way to take their fees directly from the account.

Using Your Extra Cash in All the Wrong Ways

One of the key reasons why consumers will rarely benefit from debt settlement (DS) is because after paying necessary expenses, most have hardly any money left to save for a settlement. Nevertheless, if consumers decide to use DS, it is imperative that they get the most out of their limited funds. When hired, a DS company will drain consumers' funds as they charge high administrative and monthly fees so that any monthly payments set aside in the “reserve” account will build up slowly, at best.

Depending upon the amount of the monthly payment and the amount of debt that you have, it can take years to accumulate enough money to settle the accounts. At the beginning of this accumulation phase the debt settlement company will send notice to the creditors, along with a copy of a limited power of attorney, signed by you, authorizing the company to communicate with your creditors and negotiate your accounts. As your money accumulates in an account and nothing but a "piece of paper" is sent to your creditor, ask yourself: what services is the debt settlement company providing while they charge you a monthly service fee? Learn about the services provided in "Hiring a Debt Settlement Company - The Risks."

When are the Fees Due?

DS companies rarely charge their fees when a debt is settled; some DS companies charge their fees all in advance, but most charge their fees over time.

The Fee Structures - Unreasonable and Unaffordable

Most DS companies have usually don't advertise their fee structures because they claim each person has a different situation and needs an personalized fee structure. The reality is they have very high fees that are not only unreasonable and unaffordable for many consumers, but also take away valuable resources the consumer could use to actually repay debts.

Contingency Fee Structure

• Administrative fee (3% to 6% of debt enrolled)

• Monthly service fee (usually 10% of your monthly payments or $30 to $80 per month)

• Negotiation or "settlement" fee (25% to 30% of savings on each account settled)

Example: You have one account which has accumulated to $30,000 of debt. You hire a settlement company that successfully gets a creditor to settle for 50% or $15,000. The DS company advises and you agree to a 24-month payment program. Consider that you now need to save at least $625 a month to pay off $15,000 worth of debt. At this point, we have not accounted for any of the fees charged by the DS company. Let's add up the fees.

Over 24 months, the DS company charges you a:

-4% administrative fee of $50 per month (4% x $15,000 =$600. $600/24 = $50)

-10% service fee of $62 per month (10% x $15,000 = $1500. $1500/24 = $62)

-25% settlement fee of $156 per month (25% x 15,000 = $3750. $3750/24=$156)

In total, you will pay $268 in fees to the DS company. With the initial payment of $625 and the fee of $268, you will pay $893 per month for 24 months. The three different fees paid to the DS company add up to $6,432 ($600 administrative, $1500 in monthly fees, plus $3750 in negotiation fees). So your total payout will be $21,432 ($15,000 to the creditors, plus $6,432 in fees). In other words, you can accomplish the same result if you get the creditor to settle for 71% of the total debt. If a debt has been delinquent for over 6 months, most creditors will easily settle for 70%-80% without any real negotiating effort on your part and will probably settle for 50%. At the minimum, you'd save $6,432 by doing it yourself.

Front-Loaded Fee Structure

• Flat rate fee from the percentage of enrolled debt (12% to 16%), which is paid over the first 10 to 24 months of a 12-36 month payment plan.

• Monthly service fee (usually 10% of your monthly payments or $30 to $80 per month)

Example: You have one account which has accumulated to $30,000 of debt. You hire a settlement company that successfully gets a creditor to settle for 50% or $15,000. The DS company advises and you agree to a 24-month payment program. Consider that you now need to save at least $625 a month to pay off $15,000 worth of debt. At this point, we have not accounted for any of the fees charged by the DS company. Let's add up the fees.

Over 24 months, the DS company charges you a:

-15% flat rate fee of $187 per month. (15% x $30,000 = $4500. $4500/24=$187)

-10% service fee of $62 per month. (10% x $15,000 = $1500. $1500/24 = $62)

In total, you will pay $249 in fees to the DS company. With the initial payment of $625 and the fee of $249, you will pay $874 per month for 24 months. The two different fees paid to the DS company add up to $6,000 ($4500 flat rate fee and $1500 in monthly fees). So your total payout will be $21,000 ($15,000 to the creditors, plus $6,000 in fees). In other words, you can accomplish the same result if you get the creditor to settle for 70% of the total debt.  If a debt has been delinquent for over 6 months, most creditors will easily settle for 70%-80% without any real negotiating effort on your part and will probably settle for 50%. At the minimum, you'd save $6,000 by doing it yourself.

For the sake of comparison, the above examples are over-simplified because the debt level will not remain static at $30,000, but will inflate with interest and fees for at least the first six months (assuming your payments were only 30 days late at the time you enrolled with the DS company).

How Can Someone Afford to Make Such Steep Payments?

If you already have enough money to make a settlement offer, whether you pull the money from their home's equity or a 401(k), there is no need to pay a DS company to simply negotiate a better deal. A DS company can never negotiate a better settlement than you can do for yourself.

For someone with no extra monies, consider how they are supposed to save an extra $500-$900 a month for 12-36 months; it's highly unlikely. This is why DS companies advise their clients to stop paying most or all of their other bills. These evil companies convince their clients this is the only way to save enough money to settle any debts. Later on, these clients get sued and lose everything: their homes, their credit, their future. Read "Hiring a Debt Settlement Company - The Risks," and learn why most DS companies, instead of providing real service, actually cause financial harm to the consumer.

Real Life Examples

The following examples result from a survey dsone by the National Consumer Law Center on a few DS companies and their fee structures.

1. One company charges 15% of the settlement amount ultimately paid by the consumer, plus an up-front fee that starts at $300/month for the first three months plus administrative fees of $112/month.

2. A Better Business Bureau report about one company in our survey found that the company charged an administrative fee plus 25% of settlement savings. The agency also documented numerous complaints from consumers that withdrew from the program, but were not given refunds. According to 2004 documents, this company charged the 25% fee even if the consumer settled the debt on his own, as long as he was enrolled in the program at the time. At this time, the administrative fee was a one time fee of 3% of the total debt amount or $995, whichever was greater. The company also charged a monthly maintenance fee.

3. A case against a law firm debt settlement company illustrates the serious harm to consumers that arises from companies that charge exorbitant fees and provide little or no services. The client in this case had $18,000 in debt from American Express. The agreement authorized the firm to withdraw $300/month from the client’s bank account. For the first four months, the agreement stated that $284 would be allocated to the monthly office fee, zero would be allocated to the creditor reserve fund (for debt settlement) and $16 would be charged for a monthly account maintenance fee. For the next 13 months, $142 would be allocated to the monthly office fee, $142 to creditor reserve fund and $16 to monthly maintenance. For the next 19 months, $284 would go to creditor reserve and $16 to account maintenance.

The company also charged a 28% reduction of claims fees resulting from the completion of the program. If not completed, the firm still charged $500/month in administrative costs with a maximum of $1500 and $150/hour in litigation costs, with a maximum of $1500/case. The client dropped out of the program and successfully challenged the law firm’s attempt to collect the maximum fee.

4. Another company charges a monthly fee of $10 for each account with a minimum of $40 and a maximum of $70. The company also charges a fee of 25% of actual savings. The twist in this case is that if a settlement is made, the company merely sends the consumer a packet in the mail and instructs the consumer to settle on his own

5. The receiver’s report from the National Consumer Council lawsuit includes detailed information about fees. At the outset, the company charged 3.5% of outstanding credit card debt or $500, whichever was higher. The monthly fee was $45/month for the first six cards and $3/card for each additional card. The company also charged $15 for bounced checks and $10 check handling fees. If a settlement was made, they charged 25% of money saved. These monthly payments were deducted automatically from the consumer’s checking account.

No funds were directed to the consumer’s reserve account until the set-up and accumulated monthly fees were paid in full. Ultimately, for a period from 2002 through 2004, only 1.4% of the company’s clients completed the program. Of this small group, 29% of the money paid by clients was for fees. For the overwhelmingly majority that did not complete the program, 64% of funds paid were for fees.

6. According to a lawsuit filed by the FTC against Better Budget in November 2004, consumers were promised that the company would negotiate with creditors for a non-refundable retainer fee, monthly administrative fees of $29.95 to $39.95 and 25% of any savings.

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