A Roll of the Dice: Debt Settlement Still a Risky Strategy for Debt-Burdened Households

IntroductionAlthough aggregate consumer debt levels have declined in recent years, many American house-holds remain highly indebted. The total outstanding credit card debt for all U.S. households exceed $700 billion, and the average American household carrying a credit card balance owes about $15,800 (Chen, 2015; Federal Reserve Bank of New York, 2015). One in five credit card users who carry a balance pay only the minimum each month, thereby accruing significant interest and prolonging the amount of time they will remain indebted (Morrison, 2013).If this debt load becomes unmanageable, a consumer has a few options other than continuing to make minimum monthly payments until the debt is eventually retired. Some options provide a process by which the consumer and her creditors enter into an agreement regarding how the debt will be handled. For example, the consumer could file for bankruptcy, resulting in either a liquidation of the debt or the establishment of a repayment plan. A consumer alternatively could reach individual agreements with each creditor on her own or, through a credit counseling agency, could set up a debt-management plan to which all creditors agree. These agreements usually require the consumer to repay the full outstanding balance but may waive the interest and fees.Debt is an alternative approach to dealing with debt, especially credit card debt. This option is marketed through television and radio ads, with the promise of being able to pay less than the balance currently owed, which may make it seem like a more attractive and affordable option. When consumers enroll in a debt-settlement program, they stop making payments on their debts (if not already in default) and instead may be directed to save funds into a dedicated account (GAO, 2010). Consumers also must grant the debt-settlement company, typically through a power of attorney, the authority to negotiate on their behalf and cease any contact with their creditors.After the dedicated account has an adequate balance, the debt-settlement firm attempts to negotiate settlements with the consumer's creditors for less than the amount owed. Settlement agreements can be structured to be paid from the dedicated account in a single, lump-sum payment or, more frequently, as a term settlement with a series of payments made time from the dedicated account. Term settlements can range in length from just a few to more than a year.1 The debt-settlement company earns its fee after the consumer agrees to the agreement negotiated with the creditor and after at least one payment is made to the creditor, regardless of whether it is the sole payment or the first in a series. To settle most or all of their debts, consumers typically need to remain enrolled in a debt-settlement program for 3 to 4 years (Regan, 2013).Debt-settlement advertisements claim that typically consumers see over 50% of their debt written off..and are . .debt free in as little as 36 months (DMB Financial, 2013). Debt-settlement companies promote themselves as being faster and less expensive than slowly paying off credit card debt through minimum payments and as providing a less drastic strategy than filing for bankruptcy (Freedom Debt Relief, 2013a, 2013b; US Financial Options, 2013). Debt settlement, however, comes with significant risks not present in the other options previously outlined that involve an upfront agreement between a consumer and her creditors. Two key differences between debt and other approaches is that (1) consumers using debt slop payments to their creditors and thus default on their debt and (2) consumers face the risk that the creditor will refuse to negotiate with the debt-settlement company and instead pursue collection activity or even a lawsuit against them after they stop payment.In this article, I summarize existing findings from state and federal regulators and discuss research on the significant uncertainties and risks consumers undertake when enrolling in a debt-settlement program. …