Editorial Policy

4 signs that a debt settlement firm is a scam

Allie Johnson

December 23, 2014

If you're looking for a way out of debt, watch out: That company on TV that promises a quick solution might make your problems worse.

“There are a lot of scams out there,” Ira Rheingold says of the debt settlement industry. He's the executive director of the National Association of Consumer Advocates, a nonprofit association of consumer attorneys and advocates.

In fact, in December 2014, the Consumer Financial Protection Bureau (CFPB) announced that a New Jersey debt settlement company will pay a civil fine of almost $70,000 for illegally charging upfront fees and failing to deliver promised services.

The penalty is equal to the amount of fees collected upfront from consumers who did not get effective services from the company, Premier Consulting Group, and wound up deeper in debt, according to the CFPB.

“There's always the opportunity to be taken advantage of when you're in debt and you're desperate,” Rheingold says.

How to spot a debt settlement scam

Consumers should steer clear of any debt settlement firm making promises that sound too good to be true, Rheingold says. “Don't go with a company that advertises on TV at 2 a.m.,” he says. “That's a pretty good warning sign.”

But there are a few other telltale signs that can tip off consumers that they might be dealing with a questionable company. For example, some companies:

Advertise attorney services. Many debt settlement outfits use a lawyer as a front, says Andrew Pizor, a staff attorney at the National Consumer Law Center. “They claim if you hire them, an attorney will handle your case,” says consumer debt expert Steve Rhode. However, you might meet with an attorney only briefly, if at all, Pizor says: “The attorney does virtually nothing.”

“We help make legal services available to people who have nowhere else to turn.”
-Jeffrey Katz, Morgan Drexen

In 2013, the CFPB sued Morgan Drexen, a company that provides support services to law firms, alleging that the company runs TV ads stating: “Put a lawyer on your side.” But non-attorney employees handle everything from client intake to communication with creditors to settlement offers, according to the CFPB complaint. But the CFPB has it wrong in this case: Morgan Drexen is not a debt settlement company, says Jeffrey Katz, general counsel for Morgan Drexen.

The company offers services that allow attorneys to take on a higher volume of clients and still handle all the work that requires a law license, Katz says. “We help make legal services available to people who have nowhere else to turn,” he says, citing a hypothetical example of an elderly woman whose husband dies, leaving her inundated with medical debt. “We consider ourselves to be the good guys.”

Collect fees before settling debt. Some debt settlement firms use attorneys to try to skirt a 2010 Federal Trade Commission ban on telemarketing companies collecting upfront fees for debt settlement, Pizor says, adding that some states exempt attorneys from debt settlement rules. Consumers should steer clear of any company that asks for more than a nominal fee of, say, $10 before providing services, Pizor says. “Anyone who insists on payment upfront is likely to be a scam,” Pizor says.

Pose as a government agency. Did you hear a radio ad or get a letter saying that some new government program is going to help wipe away your debts? “Run far away,” Rheingold says. One debt relief company in New York, Mission Settlement Agency, impersonated a government agency to lure customers, according to a 2013 complaint by the CFPB. The CFPB said Mission sent out letters bearing the seal of the United States, claiming to be from the non-existent “Office of Disbursement.” In fact, Mission's fraudulent debt relief service had no connection to the U.S. government, according to the CFPB. In November 2014, the owner of the company was sentenced to nine years in prison.

Make big promises. Watch out for anyone who tells you they can make your debts disappear or guarantees they will cut the amount you owe by a certain percentage, Pizor says. “They lie about their results and what they can accomplish,” Pizor says of debt settlement fraudsters.

What to do instead of debt settlement

So, what should you do about that crushing debt?

One option for some consumers is bankruptcy — either Chapter 7, in which many debts are wiped away, or Chapter 13, in which you repay a certain percentage of your discretionary income to your creditors for three to five years, then you're done, Pizor says.

“It's basically like a debt settlement program supervised by the court,” he says.

However, bankruptcies remain on your credit reports for many years, affecting your ability to borrow, renting apartments, getting good insurance terms and even impacting employment. Also, many consumers and types of debt don't qualify.

“They lie about their results and what they can accomplish.”
-Andrew Pizor, National Consumer Law Center

There is also debt counseling, in which a nonprofit debt counseling agency negotiates on your behalf to reduce interest and fees. You pay down debts with a single monthly payment. However, that is not the solution for most for a variety of reasons, including insufficient funds.

Another possibility is doubling down on your payments, and getting creative with your cost-cutting measures. You can also sell items you no longer need. Finally, know that paying off the debt isn't all you need to focus on — you need to learn how to stay out of debt as well.

Still want to use a debt settlement company?

Even if a debt settlement company is operating within the bounds of the law, hiring one might not be the best move. “Oftentimes, you wind up in deeper trouble,” Rheingold says. Even if the debt settlement is successful, your credit will take a hit because lenders will see that you didn't pay the debt in full, and they only work with unsecured loans, such as card debt.

Also, many debt settlement companies advise customers to stop paying their bills immediately based on the idea that creditors will be more willing to settle more severely delinquent debts, Pizor says. So, interest and fees keep accruing and debts balloon, according to the CFPB. Also, some companies provide such poor service that consumers get frustrated and just go away, Rhode says.

Instead of signing up with the first debt settlement company that offers a “magical solution,” consumers should do research, Rhode says. Talk to several different professionals, including credit counselor, a bankruptcy attorney and even a debt settlement company, about your situation, Rhode recommends.

“That way, you have a good chance of coming up with a solution that works for you,” Rhode says.