The Unsettling Truth about Debt Settlement
It begins with a phone call. “Help! I’m being sued for a debt, but I don’t know why— I’m paying it off with this company.” Most people think that they’ve consolidated their debts and that they are making a simplified monthly payment to all their creditors when they make auto-payment each month. The sad truth is that these clients signed up for a debt settlement plan with a private debt settlement company, a legal, but unscrupulous business practice.
How does it work?
Their advertisements run rampant on Facebook, TV, radio, and other outlets, including in different languages. Promises of reducing monthly payments on your existing debt and making your debt easier to manage, it’s easy to see why so many people are willing to listen and perhaps, suspend belief. People who have been struggling to juggle a lot of payments to different companies, but have been paying nonetheless often sign up in hopes of managing their debt. Once signed up, the debt settlement company sets up automatic payments from your account to a “special purpose account”. From your point of view, this is what you hoped for, no more debt collection calls, and only one payment to manage. But on the back end, the debt settlement company has told your creditors to stop contacting you (which you can do yourself for free), and more importantly, they have stopped paying your creditors in order to force your debt into “charge off” status.
The charge off status gives the creditors more flexibility to negotiate the debt to a lower settlement amount. American Fair Credit Council (AFCC) member, Freedom Debt Relief, tells consumers “… the most effective way to get creditors to negotiate is by showing them you are unable to pay your debt in full due to a financial hardship. Letting your payments go into default is a good way to do this. Once your creditors understand that you are unable to pay in full, they are more likely to accept a reduced amount as settlement.” (Freedom Debt Relief, Can You Settle Credit Card Debt If You Are Still Current?, Question to Frequently Asked Questions, https:// www.freedomdebtrelief.com/faq/ (last visited Mar. 10, 2021).
Immediate and Lasting Impact on the Credit Report
Because consumers who enter a debt settlement agreement are usually current on their payments to their creditors, albeit usually paying the minimum payment, their credit scores immediately drop because of this model. The credit score—a numerical representation of the information found in the credit report— reflects going from on time to suddenly all enrolled accounts being 30, 60, 90, 120, 180 days late, at which point a charge off is reported. Valid entries on a credit report will remain for typically seven years, a severe consequence for people in competitive housing areas like Alameda County.
How is this legal?
In 2020 and 2021, EBCLC led the charge on regulating the debt collection space in California. Prior to this, there was no regulation available for individuals, and little was pursued by law enforcement agencies. In shaping the law, we found that regulation is a much more viable answer than an outright ban because research on states that ban debt settlement practices (making it a misdemeanor) still had debt settlement taking place and no recourse for victims. The Fair Debt Settlement Practices Act (the Act) gives impacted people a right to statutory damages (damages under the law) and attorneys’ fees and costs (so that you don’t pay for legal services out of your own pocket).
Your Rights under the California Fair Debt Settlement Practices Act
Debt Settlement Providers Cannot Engage Certain Acts and Practices
For years, debt settlement companies could engage in questionable practices without repercussions. The Act put a stop to this.
Under the Act, debt settlement providers or those working on behalf of providers cannot make statements or engage in fraudulent, deceptive, or misleading acts. Additionally, debt settlement providers cannot omit material information to you.
Debt Settlement Companies Must Provide Certain Disclosures
Under the Act, debt settlement companies must provide you with a written contract containing certain disclosures. They must also give you a copy of the contract no less than three days before you is expected to sign the contract. Once you sign it, the provider will also provide a signed copy. The disclosures that debt settlement companies must include in their contracts are as follow:
The company doesn't guarantee that any debt will be avoided or all debts will be reduced, eliminated, or settled.
The deposits a consumer makes will not be given to the creditor until a settlement is obtained, which could take months.
If the consumer stops paying the creditor, the creditor may attempt to collect the debt or sue the consumer. The creditor can garnish wages and levy bank accounts if they successfully obtain a judgment.
If the consumer fails to pay debts, it may affect their credit score.
The debt settlement company cannot predict or guarantee specific results, and the company cannot require creditors to negotiate or settle a debt.
The consumer can cancel the contract with the company at any time without penalty.
Debt settlement services may not suit every individual's needs.
Bankruptcy is an alternative to debt settlement.
Canceled debt may be deemed as income under federal tax law.
Certain sources of income may be protected from debt collection, including disability and life insurance benefits.
The number of months the company estimates it will take to enter into settlement agreements to completely resolve debts.
Conditions the consumer must satisfy before the company makes a debt settlement offer to creditors.
Whether the company receives referral fees.
If a debt settlement company does not include these disclosures in their contract, they have violated the FDSPA.
Debt Settlement Providers Are Not Entitled To Payment Before Certain Actions
For a debt settlement provider to request payment for their services, certain details must be true, including:
The provider has renegotiated, settled, reduced, or altered the terms of at least one debt according to a settlement agreement which the consumer must first approve.
The consumer has made at least one payment to a creditor after establishing a settlement agreement.
The fee the provider is requesting must either have some proportional relationship to the amount of the debt the provider negotiated, settled, or reduced or represent a percentage of the amount the consumer has saved because of the negotiation, settlement, or reduction of the debt.
If all of these have not occurred, a debt settlement provider cannot request or receive payment from you.
You Are Allowed To Terminate Contracts For Debt Settlement Services
Previously, debt settlement services could penalize consumers for terminating their contracts.
Now, under the Act, you are allowed to terminate their contract with debt settlement providers at any time without any fees or penalties, so long as they reasonably notify the provider orally, in writing, or electronically.
You Are Allowed To Sue For Violations Of Provisions Under The Act
You can sue debt settlement providers for violation of the Act. In your lawsuit, you can pursue recovery of:
Statutory damages of no less than $1,000 and no more than $5,000 per violation
Any actual damages the consumer suffered due to the provider's violations
Injunctive relief, meaning a court order compelling action or prohibiting some act
Any other relief the court sees fit
Additionally, if the lawsuit is successful, the court can award you reimbursement of fees associated with their lawsuit and attorney fees.
It is important to note that if you wish to file a lawsuit, you have four years to do so. The four years begin on either the last date of payment or the date the you discovered or should have discovered the facts that resulted in a lawsuit. It’s important to note that this law is not retroactive, so if you engaged in a debt settlement contract before January 1, 2022, you will not have a claim under the Act.
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