On July 29th, 2010, the Federal Trade Commission (FTC) announced new regulations for the debt settlement industry. For background, please see the following ZipDebt blog posts:

FTC Workshop on the Debt Settlement Industry
Debt Settlement Industry in the Crosshairs
Debt Settlement Industry – Big Changes Coming Soon?
Will Debt Settlement Still Exist in 2011?

Frankly, the debt settlement industry should have been regulated years ago. The new rules were far too slow in coming for the tens of thousands of consumers who have been ripped off by shady debt settlement companies. But at least the day has finally arrived. As of September 27, 2010, new disclosure requirements go into effect that will ban much of the deceptive debt settlement advertising that has saturated media airwaves in recent years. And even more importantly, as of October 27, 2010, firms will no longer be permitted to charge fees in advance. This will put an end to the practice of charging 15% of the total debt before meaningful work has been performed. Companies will be required to actually obtain settlements before earning a success fee. (Oh, the horror!) In order to survive the coming changes, companies will be forced to revert to a fee model based on percentage of savings – most likely the old 25% of savings method originally used in the “good old days” of debt settlement.

What will be the practical effects of these new regulations on consumers looking to debt settlement as an option? There are some rather obvious implications, as well as some potential effects that are not readily apparent at first glance.

Among the obvious effects are an expected sea change in the way debt settlement services will be advertised. Yes, I’m sure that some of the sharks and cowboys will go right on advertising the same old deceptive pitch after 9/27, but eventually two or three large marketing firms will get shut down by the FTC. A couple of major enforcement actions will finally convince some of the more stubborn players out there the game really has changed for keeps. Once the drip-drip-drip of false advertising starts to dry up, then debt settlement sales “leads” will also start to dry up and the front-end marketing machine will die down. Many of the call-center marketing firms that entered the field to exploit recent economic conditions will abandon the industry and move onto selling some other type of product or service.

Next, and also obvious — after the advance fee ban goes into effect on 10/27, numerous firms will still be out there operating on the old upfront fee model, or they will try to exploit non-existent “loopholes” that still permit the big advance fees. Here again, a few major enforcement actions to take down non-compliant firms will probably happen before 2010 is over, or early in 2011. I’m sure the FTC wants to prove its point, so look for them to take down one or two firms for continuing to charge non-compliant fees. I also predict that at least one major enforcement action will involve a settlement firm operating on the so-called “attorney model for debt settlement.” Many people in the industry falsely believe they are safe if they have an attorney at the head of their settlement firm. But the FTC has specifically said that the new rule *does* also pertain to attorney debt settlement, so there is no such loophole. Still, some idiot will try, and get shut down for it, thus providing a nice test case for the FTC.

Moving forward past the massive turmoil that will happen well into 2011, there will rise to the top several larger firms that are well capitalized. These firms will make a legitimate attempt to implement debt settlement in large volume using the percentage-of-savings model. The FTC ruling does not cap the percentage of savings fee structure. So provided the much more harsh Schumer bill or the House equivalent (which would cap fees at an industry-killing 5-10% of savings) does not pass through Congress and there are no further fee restrictions implemented, then at least a few reputable large settlement firms will try to remain standing. Some have already announced their intention to comply.

Another potential consequence of the advance fee ban, perhaps less obvious than those discussed above, is the coming shift in marketing demographics for debt settlement. The key question for debt settlement executives will quickly become – How can we actually deliver on our promises to effectively reduce consumer debt through third-party negotiation tactics, and still earn a profit? Once these firms start having to actually EARN their fees (instead of just collecting up front while clients drop out left and right), the target demographic for debt settlement will shift *drastically*. Until now, *anybody* with a $10,000 credit card debt load was “fair game” for industry sales reps. Most companies sold the service based on the long-obsolete 36-month debt settlement program, or worse, fairy-tale 48-60-month programs. All of that silliness will disappear as companies compress the timeframe in which they permit clients to stretch the program. With all the fees at the back-end, the 36-month programs will gradually shrink to shorter and shorter durations. Companies will actually start to perform suitability analysis before taking on clients, to ensure that they are a good fit for the settlement strategy. In short, the reputable firms left standing will quickly begin to learn all the same things I learned many years ago – settlement only works if the client is a good fit for it financially. Just being in debt is not sufficient qualification! The result will be that debt settlement will only be presented to consumers who have a reasonable shot at making it work effectively, and this will be a fraction of the demographic pool the industry had originally targeted. In other words, the debt settlement industry will shrink drastically over the next 1-2 years, leaving only a few large firms and a greatly reduced number of small to mid-sized firms, down from well over 1,000 companies today.

No matter what they do, however, even the legitimate debt settlement firms will still be swimming against the tide. Irreparable damage has been done to the industry’s reputation due to the extremely shoddy marketing practices of the past 10 years. The top ten major credit card banks have taken a unified stand against third-party debt settlement. They won’t talk with these firms anymore. So even the client of these “cleaned up” debt settlement firms will be working at a SEVERE disadvantage. Clients of debt settlement firms will still be required to wait beyond charge-off before the majority of their debts can be settled. This enormous handicap automatically drags out the process and places the client at much greater risk of legal action. Unfortunately, in the current banking environment, hiring a debt settlement company is rather like calling an electrician to come repair your defective house wiring, and then being told the job can only start *after* the fire has already taken place!

There is at least one other important potential consequence of this ruling that might not be apparent at first glance, until you take a deeper look at the economics of trying to run a debt settlement company with no front-end revenue. There remains one possible method of getting some revenue at the outset. The FTC has provided an exemption for “products.” This was a wise exemption, mind you, because any rule change that tried to include books, tapes, CDs, etc., would automatically lead to First Amendment issues. Basically, the lawyers would have had a field day, and any such provision would have been stricken by some court ruling anyway, so the FTC left it alone in order to not weaken the main elements of the rule change.

What does the “products” exemption mean in practical terms? Well, it’s good news and bad news. It’s quite good news for me personally, and ZipDebt clients (current and future) as well, since it means that the ruling does not apply to my business model. I sell a product, and I don’t meet the definition of a debt settlement service provider anyway. So yours truly will still be able to help consumers navigate the mine field of credit card debt settlement, minus the big fees. And let’s face it people – 25% of savings is still a HUGE chunk of money! If you owe $80k, and the firm settles for 40% average, you will still pay $12,000 in fees for something you could have done yourself with a little proper training and guidance. I think $777 is a much more reasonable cost, don’t you? 🙂

So what’s the bad news then? Well, I hope I’m wrong, but I expect that we’ll now be treated to an onslaught of new “products” – debt-related e-books and DIY debt settlement kits, including knock-offs of my own training course, and so on. We’ll have a deluge of debt-settlement related products, all designed to give desperate companies some breathing room –something solid to base a little front-end revenue upon. Most of this material, of course, will be flimsy at best, and much of it will contain outdated advice. Therefore, it will still be “buyer beware” for people looking for help with their debt troubles.

In short, the FTC ruling will help consumers avoid the minefield of debt relief services, especially after some of the worst offenders are chased from the industry. But consumers will still need to do their homework, check Better Business Bureau ratings (you can check ours here), and perform proper due diligence before working with any third party debt settlement firm – especially one that just started hawking books, tapes, and CDs after July 29th!