Companies that promise to reduce or eliminate credit card balances and other debt for customers will no longer be allowed to charge an upfront fee.
The Federal Trade Commission said Thursday that the new rule is intended to crack down on the debt settlement industry, which has flourished in the downturn as borrowers struggle to pay their bills.
The rule goes into effect Oct. 27.
Since the start of the recession, the Better Business Bureau has received more than 3,500 complaints about debt settlement companies. Customers who hired the companies complained that they ended up deeper in debt, or ended up being sued by creditors.
Debt settlement companies often charge an upfront fee, typically a percentage of the customer's outstanding balance. In exchange, the company promises to negotiate with creditors to reduce or eliminate the debt, sometimes by as much as half.
In addition to the upfront fee, customers are often required to set aside money in a separate account maintained by the debt settlement company. This money is intended to eventually pay off any remaining debt.
Under the new rule, however, companies will only be able to require such an account if it's maintained at an independent financial institution under the customer's name.
The customer must also be able to withdraw the money at any time without penalty. And customers can only be charged a fee once their debt has been reduced, settled or renegotiated.
Debt settlement companies will also have to disclose to customers how long it will take to get results, how much it will cost, and any negative consequences that could come from the process.
For example, customers can get buried deeper in debt when they hire a debt settlement company.
This is because customers stop making payments on their loans, and late fees and interest charges continue piling up.
Debt settlement companies that violate the new regulations will be subject to a $16,000 fine per violation. The Federal Trade Commission's rules only apply to for-profit companies. But the agency warned that it would go after companies that pose as nonprofits as well. Regulators cautioned customers to be wary of any organization that charges a steep upfront fee and makes promises that sound too good to be true.
By comparison, nonprofit credit counseling agencies often charge a small nominal fee for help managing debt. The agencies advise borrowers to try negotiating directly with creditors, rather than enlisting a debt settlement company, especially if they only have one or two loans.
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