The Debt Consolidation Trap: Legal Protections Against Scams

Debt consolidation can simplify your payments; debt settlement can sometimes reduce what you owe. Neither option gives a company a free pass to charge whatever it wants or promise results it can’t deliver. If a debt relief provider demands money before doing the work, guarantees that it can eliminate your debts, or glosses over the consequences of its program, you may be looking at more than a bad financial deal.

If you believe a debt relief company took advantage of you, a credit repair lawyer can help you understand your options.

What Is the Difference Between Debt Consolidation, Debt Management, and Debt Settlement?

Advertisements often use the terms “debt consolidation,” “debt management,” and “debt settlement” interchangeably. They aren’t the same thing. Each approach handles debt differently, and each comes with its own risks. Understanding the difference can help you spot a questionable offer before you sign up.

Debt Consolidation

Debt consolidation generally means combining multiple debts into a single debt consolidation loan or payment plan. Instead of keeping track of several credit card or loan payments, you make one payment to the new lender or provider.

A consolidation loan may come with a lower interest rate, which can make repayment more manageable. But a lower monthly payment doesn’t necessarily mean you’ll pay less overall. A longer repayment period can increase the total interest you pay, while a variable interest rate could make future payments more expensive. And if your home or another asset secures the consolidation loan, falling behind could put that property at risk.

Debt Management Plans

A debt management plan, or DMP, generally involves working with a credit counseling agency to create a structured repayment plan. You typically make a single payment to the agency, which then distributes the funds to your creditors.

A credit counselor may also negotiate with creditors for lower interest rates, reduced fees, or other repayment terms. Unlike debt settlement, the goal generally is to repay the enrolled debts in full under more manageable terms.

Debt Settlement

Debt settlement takes a different approach. A settlement company generally attempts to negotiate with creditors to accept less than the full amount you owe. Some programs encourage consumers to stop paying creditors while money accumulates for potential settlements.

Missed payments can damage your credit, while interest and fees may continue to accrue. Creditors can continue collection efforts and may file lawsuits. And there is never a guarantee that a creditor will agree to settle.

Hidden Risks of Debt Relief Programs

Debt settlement programs can look attractive when you’re struggling to keep up with multiple accounts. Instead of paying creditors directly, some programs instruct consumers to stop making payments and deposit money into a dedicated account. The company then uses those funds to reach settlements with creditors.

That approach can carry significant consequences. While you wait for enough money to accumulate, interest and late fees may keep adding to your balances. Creditors can also continue collection efforts, and nothing necessarily prevents a creditor from filing a lawsuit over an unpaid debt. If the settlements take longer than expected, you could end up owing more than you did when you entered the program.

Be especially skeptical of a company that promises to make your creditors “stop calling” or guarantees that it can settle your debts for a specific percentage of what you owe. A debt settlement company doesn’t control whether a creditor will agree to its proposed terms. A promise of a guaranteed result should prompt some serious questions about what the company can actually deliver.

Nonprofit Credit Counselors vs. Commercial Debt Relief Companies

A nonprofit label can sound reassuring, but don’t assume it tells you everything you need to know. Nonprofit status and federal approval are different.

A credit counseling agency may operate as a nonprofit without being approved by the U.S. Trustee Program to provide bankruptcy counseling. Federally approved agencies must meet additional requirements designed to protect consumers.

What Federal Approval Requires

Federally approved bankruptcy and credit repair agencies must satisfy requirements concerning their structure, operations, counselors, fees, and handling of consumer information and funds.

For example, an agency generally must operate as a nonprofit organization and have an independent board. Its counselors must meet education and training requirements, and the agency can’t pay counselors commissions or bonuses based on a client’s financial or legal decisions.

Commercial Debt Relief Regulatory Framework

A commercial debt relief company isn’t automatically a scam simply because it operates for profit. But it doesn’t receive the same federal approval simply because it offers credit counseling or debt settlement services.

Depending on what the company does, it may instead be subject to federal consumer protection laws, state licensing requirements, and rules governing debt relief and telemarketing.

FTC’s Telemarketing Sales Rule

When a debt relief company reaches you through telemarketing, federal law places limits on what the company can promise, what it must disclose, and when it can collect its fees. The Federal Trade Commission (FTC) enforces the Telemarketing Sales Rule (TSR), which includes specific protections for consumers purchasing debt relief services.

The TSR applies to certain debt relief services offered through covered telemarketing. The definition is broad. It can include services that claim to renegotiate, settle, reduce, or otherwise change the terms of unsecured consumer debt. The rule can apply when a company calls you directly, but it can also apply when you call a company after responding to an advertisement or other solicitation.

That distinction matters because a company can’t necessarily avoid the TSR simply because you made the first call. The way the service is marketed, and the nature of the transaction determine whether the rule applies.

TSR and Upfront Fees

When the TSR applies, a debt relief provider generally can’t demand its fee before doing what it promised. Before collecting a fee, the provider generally must have:

• Successfully renegotiated, settled, reduced, or otherwise changed at least one debt;
• Obtained your agreement to that new arrangement; and
• Had you make at least one payment under the arrangement.

That doesn’t mean a company can settle one account and then send you a bill for its entire fee on every debt you enrolled. The TSR also limits how providers can front-load their fees when multiple debts are included in the program.

Required Disclosures

Debt relief companies must also give consumers important information about what they’re buying. That can include how long the process may take, what it costs, how much money you’ll need to set aside, and what could happen to your credit or expose you to continued collection efforts.

A company can’t simply throw around impressive numbers and hope you won’t check them. Claims about savings, results, timelines, or the company’s ability to stop collection activity must be truthful.

Signs of a Debt Relief Scam

Several signs may signal a debt consolidation company is a scam. The most common marketing strategy used by debt consolidation scams is a “pay first, and the debt disappears” message.

Additionally, many scams promise guaranteed results. No legitimate provider can guarantee that every creditor will accept a particular settlement. Be wary of promises to eliminate a specific percentage of debt or achieve a guaranteed credit-score increase.

Another sign of a possible scam is strong pressure to stop communicating with creditors. Ignoring a creditor doesn’t make the debt go away, and interest and late fees keep accruing. Ignoring a lawsuit can be especially dangerous. Failing to respond by the applicable deadline can result in a default judgment, which may give the creditor additional collection options. A debt relief company also may not be able to stop a creditor from suing you simply because you’ve enrolled in its program.

Questionable companies may falsely claim affiliation with the FTC, the Consumer Financial Protection Bureau (CFPB), the U.S. Department of Education, or another government agency. This creates a false sense of security or trustworthiness.

Attorney involvement doesn’t automatically exempt a business from federal consumer-protection requirements. Consumers should determine who is actually representing them and what legal services, if any, they’re receiving.

Finally, the scam company may be vague in its terms and fee structure. This can leave consumers owing more than they did when they started working with the debt relief scam company. Additionally, the company may not take any action to secure forgiven debt. In the worst cases, the debtor could become a victim of identity theft.

What Can Consumers Do If a Debt Relief Company Violates the Law?

Consumers have options when a debt relief company violates the law. They can report suspected misconduct to the FTC and CFPB, depending on the company’s conduct and the type of debt involved. They may also report the situation to the consumer-protection division of their state attorney general’s office.

State attorneys general have express authority under the TSR to bring civil actions involving unlawful telemarketing practices and seek injunctions, damages, restitution, and other compensation for residents.

Federally, the FTC can pursue enforcement actions against companies that violate applicable consumer-protection rules. Potential remedies include injunctions, contract rescission or reformation, refunds, damages, and other consumer redress. This is administrative regulation enforcement, separate from the debtor filing a civil lawsuit to recoup damages. Consumers may also be able to file a private civil lawsuit to recoup damages.

Seek Legal Advice

Debt consolidation and debt settlement can offer legitimate ways to address overwhelming debt, but consumers should know exactly who they’re dealing with before signing a contract or handing over money. An attorney can look at the contract, communications, fees, and other evidence to determine whether the company may have violated federal or state consumer protection laws.

For help finding a credit repair lawyer who handles consumer debt and consumer protection matters, use the Super Lawyers directory.