Facts, Not Feelings, Should Inform Regulation of the Debt Settlement Industry

As money gets tight during the COVID-19 pandemic and quarantine, policy makers need to ensure that struggling households have multiple options to manage their debts and stay afloat. One such option is debt settlement, and the good news is that the Consumer Financial Protection Bureau (CFPB) is resisting zealous calls to regulate it out of existence and instead recently examined the process in a fair hearing.

A CFPB event held last month explored the options available for consumers facing high levels of unsecured debt and limited credit options. Titled “Evolutions in Consumer Debt Relief,” panelists included representatives from debt settlement, debt management, and credit counseling industries. Much of the conversation focused specifically on the matter of debt settlement and whether or not debt settlement firms help or hurt indebted consumers. Despite the negativity fomented by former CFPB Director Richard Cordray toward debt settlement companies and the pressure from so-called “consumer advocates” to further their regulation, the CFPB appears to be relying on facts rather than feelings when weighing any future rulemaking or oversight of the industry.

Debt settlement is the process by which a debt settlement firm, working on behalf of a borrower, negotiates with a creditor over the settlement and discharge of a borrower’s unsecured debt. Put another way by the Corporate Finance Institute here, debt settlement “refers to an agreement reached between a creditor and a borrower in which a reduced payment from the borrower is regarded as full payment.” While debt settlement firms act as an intermediary between a borrower and creditor, the firms do not provide legal representation or financial counseling services, nor do they provide assistance with secured debts like mortgages or car loans.

As described by former Senator Kay Bailey Hutchinson (R-TX) during a Senate Commerce, Science, and Transportation Committee hearing in 2010:

Consumers unable to fully repay their debt generally have three choices—credit counseling, where consumers enroll in a program designed to allow them to pay off the full balance of their debts over a longer period of time; debt settlement, where a third party negotiates with creditors to lower the overall balance due from the consumer; and bankruptcy.

Generally speaking, debt settlement serves those who do not qualify or who cannot afford other debt relief options, and seek to avoid the toll of filing for bankruptcy. Discussing this during the panel, Dan Frazier, CEO of Century Support Services, noted that debt settlement firms complete a robust verification to ensure each client knows what they’re signing up for and that the firms conduct regular check-ins with the client to make sure things are going okay. He also brought up the fact that unlike bankruptcy attorneys who frequently collect upfront fees, these companies only collect fees after the consumer signs off on a settlement. It’s important to also mention that certified debt settlement companies use Federal Deposit Insurance Corporation (FDIC)-insured trust accounts to protect the borrower’s payments to the creditor. 

A 2017 economic analysis of the debt settlement industry prepared by the Hemming Morse auditing firm concluded that “debt settlement results in an economic benefit for consumers.” The report showed that the completion rate for borrowers who enrolled in debt settlement and participated for more than two years exceeds 60 percent and that 96 percent of settlements resulted in debt reduction and realized savings.

Additionally, a 2018 report compiled by the John Dunham & Associates research firm found that indebted Americans saved $1.6 billion that year as a result of debt settlement programs and that creditors participating in debt settlement programs received more than $600 million in revenue that might otherwise have been delayed or not received at all. It also found that the debt settlement industry is responsible for nearly 28,000 jobs across the United States.

Debt settlement became more widely utilized as an option for consumers in the mid-2000s following the passage of the Bankruptcy Reform Act of 2005, which made it more difficult and expensive for consumers to obtain discharge of their debts. As millions of Americans fell into staggering debt in the wake the financial crisis of 2008 and 2009, the debt settlement industry grew to meet the demand. This prompted attention from the Federal Trade Commission, which in 2010 promulgated a rule that requires companies to disclose information about how long it will take to obtain debt relief and that prohibits them from collecting advance fees.

During the panel, a CFPB staffer said that three main developments have piqued the bureau’s interest in the debt settlement industry: 1) the amount of unsecured consumer debt and the pace at which it continues to grow, 2) the lack of uniformity in the ways in which debt collectors collect debts, and 3) how the advent of new financial products and the proliferation of consolidation loans change the lay of the land. While these are valid concerns, CFPB Director Kathy Kraninger must continue her track record of being a pro-consumer and evenhanded regulator, and the bureau must resist any urge to needlessly overregulate an industry that provides an important tool for indebted consumers working to overcome their financial struggles.

Hopefully, the CFPB will also bear in mind the fact that debt settlement companies play an even more important role in negotiating mutually beneficial agreements in times like these, as the economic crisis and COVID-19 make it more difficult for borrowers to make good on their debts.