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Rules for consumer debt and debt settlement companies

Persisting financial struggles can be one of the most difficult things an individual experiences. Credit card debt is very common, with many people carrying high average balances on a monthly basis. While some people are able to manage their debts, making minimum payments or more each month, others start to fall behind due to unforeseen circumstances like job loss, serious medical conditions, etc.

Once consumers can no longer make monthly payments, they may start to face creditor harassment, repossession and other negative effects. To stave off these consequences, many look to debt settlement as a way to get back on their feet financially. However, it is important to understand what a debt settlement company will actually do for a consumer what legal limitations on their actions exist.

Debt settlement companies are generally for-profit companies that make money by charging consumers a fee for the debts it successfully settles on the consumer's behalf or by charging a percentage of the amount a consumer saves due to the debt settlement. It is important to know that, under the Federal Trade Commission's Telemarketing Sales Rule, it is illegal for debt settlement companies to charge and collect their fees from consumers prior to actually settling the debt successfully.

The service that debt settlement companies essentially provide is negotiation with creditors. As part of this process, the debt settlement companies generally require that participants save a specific amount of money each month for a set duration of time. The total saved will eventually be used to pay a portion of the debt owed-the prospective debt settlement-in a lump sum.

There are risks involved in participating in these programs, however, because there is no guarantee that the company will be able to negotiate a lower settlement payment with creditors. In addition, they often advise consumers to cease making payments to the creditors during the "saving" period, which can result in creditor harassment, lawsuits, the accumulation of late fees, and damage to the credit score in the meantime. An additional risk for many consumers is the high rate of drop-out from these programs if the consumers are unable to successfully save the required amount of money each month. For these reasons, consumers should evaluation debt settlement programs carefully before committing in order to fully understand how the program operates and whether it is likely to be beneficial for the individual's specific situation.

Source: Federal Trade Commission, "Settling Credit Card Debt," accessed Sept. 1, 2014

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