byAndrew Housser – – September 26, 2011
New Federal Trade Commission (FTC) rules regulating the debt relief industry took effect one year ago – changes that included the well-known advance-fee ban, prohibiting debt relief companies from collecting any fees until after a result has been negotiated for and accepted by a customer. Because of these FTC rules, the entire industry has changed – and continues to evolve – dramatically. In fact, combined with an uncertain economy, fears of another recession, and rising consumer debt, the industry is experiencing the most rapidly changing business environment in its short history.
Consumer debt is not going away. The latest statistics on U.S. debt, issued in July by the Federal Reserve, show that Americans owe $2.45 trillion in consumer debt – the highest level since 2008. Of that amount, $792.5 billion is revolving debt – and although significantly lower than its peak of $972.2 billion in August 2008, it is still an enormous number. Recent data also has shown that the average American who carries credit card debt has a balance of nearly $15,000. While this figure is down slightly from the previous quarter, the fact remains that many Americans are in serious debt hardship and, in many cases, must look to obtain help in resolving that debt.
The FTC rules seek to protect those very consumers from predatory businesses looking to take advantage of them. This is considered a major step in the right direction. Over the past year, the regulations have made it easier to distinguish companies that get results for their clients from those that don’t. This result helps consumers as well as benefits the entire debt settlement industry. It levels the playing field. In addition, the regulations are an asset for the creditors with whom the industry negotiates by allowing consumers to accumulate funds more quickly in order to resolve their debts.
Pre-FTC Industry Evolution
In order to understand the impact of the rules on the industry and on consumers today, it is helpful to understand the climate – and problems – that led to the changes.
The debt settlement industry initially formed out of an unmet need of consumers struggling with debt. These consumers who have turned to debt settlement come from all economic strata. All, however, share two common characteristics: they suffer from unmanageable levels of consumer debt, primarily credit card debt; and they have few, if any, debt resolution alternatives available to them.
Unlike consumers with stable financial foundations, the typical debt settlement client either does not own a home, or cannot refinance his or her home due to lack of equity. The client also generally has a high debt-to-income ratio and a severely damaged credit score. For this most distressed consumer constituency, making minimum monthly payments, or paying their bills through a debt management program, which typically provides only modest monthly payment relief, has been out of reach. This has historically left bankruptcy as the only alternative for many.
While some mom-and-pop operations began offering debt settlement services as early as the 1990s, it was not until the early 2000s that the industry took off. As the economy sputtered in the wake of the dot-com crash, and as consumer debt exploded, the number of firms selling or providing debt settlement services began to grow dramatically. Then, three significant catalysts unfolded, leading to an explosion in the industry:
1. Many non-profit credit counseling companies began facing regulatory problems, in part due to misuse of their non-profit status.
2. The 2005 bankruptcy reform made it more difficult and expensive for consumers to qualify for bankruptcy (in particular, Chapter 7).
3. The mortgage market imploded, making it next to impossible for a consumer to use home equity as a way to pay down credit card debt.
This led to a significant decline in options available to consumers, and the gap was filled in by debt settlement companies. The industry grew from a dozen participants in 2002 to more than 1,000 firms by 2009. This rapid growth, not unexpectedly, had consequences. The practice of charging monthly fees before debts were actually resolved worked relatively well when the industry was in its nascent stage: a small number of companies, most of which took pride in their work, and maintained a strong focus on customer results. But the extraordinarily low barrier to entry and the ability to charge upfront fees led to an influx of competitors who did not share the same commitment to customer results as did the industry’s early participants.
Ultimately, consumers could not tell a good results-oriented company from a less-scrupulous one because all of the marketing claims, websites and advertisements looked the same. Many consumers signed up with companies whose results did not back up their claims. Creditors and collectors became frustrated with the industry because so many companies were collecting significant upfront fees from their clients and leaving little money for actual resolution of debts. The good players in the debt settlement industry suffered as the entire industry began to be painted with the same negative brush.
The New Regulations
Against that landscape came increased regulation at the state level, and finally, federal regulation in the form of the FTC’s debt relief amendments to the Telemarketing Sales Rule. In summary, the new rules, which the FTC details at http://www.ftc.gov/opa/2010/07/tsr.shtm, seek to protect consumers with these key provisions:
- Debt relief providers must accurately represent the results consumers can expect to achieve.
- Debt relief providers must make specific disclosures.
- Debt relief providers cannot charge any fees whatsoever before negotiating a resolution on a customer’s credit card or other unsecured debt. Specifically, companies cannot collect fees for debt relief services until the debt relief service successfully renegotiates, settles, reduces, or otherwise changes the terms of at least one of the consumer’s debts. Furthermore, the customer must approve the negotiated resolution before any fee can be charged.
For debt relief businesses, this advance-fee ban has had serious consequences. Since most of these companies relied on monthly or upfront fees to cover the cost of acquiring new customers and running their businesses, the delay in cash flow has had a significant impact.
The ban has forced many companies out of business. While this includes most of the unscrupulous players, it also has created significant challenges for the principled companies that remain. The first challenge they face is continuing to invest in customer service and negotiations with creditors when no revenue is coming in the door. These firms must find ways to be as efficient as possible while maintaining the highest level of customer service and performing high-level negotiations with creditors.
Another challenge that remaining debt relief companies face is keeping their customers committed to their programs when they have no initial up-front investment, or no “skin in the game.” Whether debt relief or other business, when consumers invest in their own well-being at the beginning of a program, chances are higher they will continue and see the process through. For the debt relief industry, this is especially true.
Now, however, debt relief companies must find other ways to engage customers and maintain their commitment. Providing successful resolution as early as possible in the program and keeping steady contact with customers as they progress through the program are key factors. Companies also are seeking to negotiate individual debts earlier in the program to generate revenue and to provide the customer confidence and motivation.
The good news is that the companies remaining in the debt relief business are ones that are here to stay for the long term, willing to invest effort and resources, and willing – and able – to lose money for at least a few years in order to build a sustainable business model with no advance fees. The upside: An industry filled with companies that operate with a responsible, long-term view is more viable from a business perspective, and better for consumers.
For the consumer, the advance-fee ban means that enrollees pay no fee of any sort whatsoever unless and until the debt settlement company negotiates a settlement – and the consumer accepts the negotiated settlement. The new regulations give consumers the confidence to know that they will pay only for results.
As a result of the advance-fee ban, the debt settlement industry has been purged of most of the unscrupulous players, leaving a core of compliant, professional debt settlement companies serving consumers well. These companies understand that if they are not meeting their customers’ needs, they will not be in business for long.
On the flip side, however, buyers must still beware. As with most rules, there are those who look to exploit the loopholes and/or exceptions, and find ways to do so. Consumers today must be able to discern whether a debt relief company is one of the ethical players or not. To help, the American Fair Credit Council (AFCC), formerly The Association of Settlement Companies, has publicly endorsed the FTC rules and is limiting membership to those companies that have agreed to adopt the no-advance-fee model.
Consumers dealing with an AFCC member can have confidence of a fair deal, and gain assurance that the company is conducting honest and fair negotiations without any incentive of any kind. They clearly are benefiting from this change; AFCC members are on pace to settle more than $1 billion of unsecured debt this year alone.
Despite the challenges, providers are seeing many benefits from the rules as well. Debt relief companies are experiencing greater acceptance by the collection and recovery communities. In this time of economic uncertainty and lingering effects of the recession, collectors are realizing that it often makes more sense to negotiate a reasonable settlement for a consumer than to spend time filing a suit, recording a judgment and then trying to enforce it.
In addition, collection and recovery professionals now have a much easier time distinguishing the truly compliant debt settlement companies from the advance-fee “loopholers”; a single “secret shopper” call to ask how the company’s fee structure works will typically tell the caller all he/she needs to know. The good news is that debt relief companies that are complying with the advance fee ban allow funds to get to creditors much more quickly. This makes both the creditors and the customers happy – a true win-win.
The new FTC regulations have effected more changes on the debt relief industry in just the past year than most industries experience over their lifetimes. And the changes will continue, as companies become more efficient, and develop and expand services. But the needs of the consumers who need debt relief services have not changed. They care about solving their debt problems, getting back on solid financial footing, and finding advocates who will help them, ethically and honestly. The debt relief businesses that focus on these issues will be those that thrive.
Andrew Housser is the co-founder and CEO of Freedom Financial Network, LLC (FFN), based in San Mateo, Calif., which provides comprehensive consumer finance resolution services. Freedom Debt Relief, LLC (FDR), a wholly owned subsidiary of FFN, provides consumer credit advocacy, also known as debt settlement, services. Working as an independent advocate for consumers to negotiate with creditors and lower principal balances due, the company has resolved more than $1 billion in debt for nearly 100,000 clients since 2002.
Housser holds a Master of Business Administration degree from Stanford University and Bachelor of Arts degree from Dartmouth College. He was awarded the Northern California Ernst & Young Entrepreneur of the Year Award in 2008.