New rules ban promises to cut your debt in half

NEW YORK (CNNMoney.com) -- New rules muzzling debt-settlement companies go into effect Monday, preventing these firms from making grandiose promises they have no intention of keeping.

In the past, these for-profit telemarketing companies promised to renegotiate consumers' debt and even potentially cut it in half. They didn't warn customers, however, about the fees they would incur -- or that it could take years to see relief.

That all changes Monday. Federal Trade Commission rules now require these debt settlement companies to be more upfront and honest about their services. That means they must disclose how much money customers will fork over and how long the settlement process will take. And they're no longer allowed to swear to cut your debt in half if they can't.

With more and more desperate consumers turning to these companies for help, consumers need to realize what they're really getting themselves into, said Evan Zullow, an attorney in the FTC's division of financial practices.

The Association of Settlement Companies, one of the major industry organizations, estimated that as of June 2009 its members served about 154,000 active consumer clients and managed more than $4.9 billion in debt. That was up from 2008, when its members had 123,000 customers and managed $4 billion in debt.

Complaints of abusive and deceptive practices filed with the FTC have also risen, jumping 18% between 2008 and 2009.

"Consumers have been led to expect that results are going to come much quicker and more easily than they do, and that draws them in and gets them to enroll," said Zullow. "So we want them to know how much money and time they are really going to have to invest to get those results."

No lying: While it may seem like a given, debt settlement companies are now banned from misrepresenting themselves. That includes saying the company is non-profit when it's really a for-profit or saying that it can eliminate a huge chunk of your debt when it doesn't have proof that it can do that.

Ever seen a TV commercial where a debt settlement company promises it has saved its customers 30% to 65% of credit card debt? Well, they're only counting the customers that didn't drop out of the program, which isn't a fair representation since about 60% of customers end up ditching the program before it's over, said Zullow.

Another practice they have to come clean about: When a settlement company pledges to cut your $10,000 debt in half, you would think that would mean a settlement of $5,000. But that $10,000 can easily turn into $12,000 as interest adds up over several years, and companies will often settle for half of that final amount. That means you will pay $6,000 -- 60% of your original debt -- instead of the 50%, or $5,000, that was promised.

"We want to give consumers the key information to make a decision, which might end up being to use a settlement service or not use it," said Zullow. "We just want the information to be accurate."

More transparency: Debt relief companies typically negotiate with credit card companies to reduce interest rates, spread out payments and even cut the principal balance. But they didn't have to tell potential customers how much they would need to save to pay off the new balance -- until after they were already customers. Now the rules require these firms to provide an upfront estimate of the costs.

Settlement companies also have to tell consumers how long the process may take and are required to warn customers of any negative consequences.

For example, settlement companies with plans that advise consumers not to make monthly credit card payments are required to disclose the damage skipping these payments will do to a person's credit score.

What's brewing: These rules set the stage for an even bigger provision coming next month, which will ban upfront fees -- a key source of revenue for many debt relief companies.

Beginning Oct. 27, customers won't have to pay a cent in fees until they see results, meaning that their debt is settled or reduced.

After voicing initial concern about the affect these rules will have on business practices and profits -- especially the upfront fee ban -- the Association of Settlement Companies said that it accepts the new provisions.

"While managing working capital will be tough for the industry, we think it is time to accept these rules and get back to the business of helping consumers get out of debt," TASC Board member Andrew Housser said in a statement.

Skirting the new rules: But just as banks have found ways to circumvent new Federal rules on fees, debt settlement companies may be able to just as easily skirt some of the new provisions and take advantage of struggling consumers.

Because the debt settlement rules only apply to over-the-phone sales -- which comprise the vast majority of transactions -- debt relief companies can still hit consumers with fees over the Internet. Face-to-face transactions are also exempt from the rules.

So if you're on the hunt for someone to whittle down your debt, there's still reason to be wary, said Ira Reingold, executive director of the National Association of Consumer Advocates.

"The rules will have a very good impact on ending the worst behaviors in the debt settlement industry," he said "That being said, I've been around long enough to know that the scammers won't be deterred by any rules and regulations, that they are already looking for ways to get around these rules, and that as long as there are people in desperate debt situations, they will figure out a way to take advantage of their desperation."