For-profit settlement is the wrong answer for troubled borrowers

• Key insight: Settlement services, whose debt-reduction models require advising borrowers to default on their loans, wreak havoc on their customers' credit ratings, often leaving them worse off than they were before.
• What's at stake: Two federal watchdogs warning consumers from falling into debt-settlement traps is not what a well-regulated market looks like.
• Supporting data: In 2024 the CFPB and seven state attorneys general alleged an attorney-model firm took more than $100 million in illegal upfront fees from struggling households, often without settling a debt.

Several recent op-eds have defended for-profit debt settlement firms and opposed federal legislation to better regulate them. The pieces made similar arguments and made similar attacks on the American Financial Services Association, or AFSA, but curiously failed to refute any of the facts that are most important to consumers, consumer advocates and policymakers when it comes to debt settlement. So, let's revisit those facts.

For-profit debt settlement is an industry with perhaps the oddest business model that exists, offering a service that is predicated on telling its customers to stop paying their bills in spite of the damage such a tactic imposes on a customer. That this is their core tactic is not in dispute. In fact, in his article for American Banker (Indebted Americans need help, not restrictions on settlement services, Aug. 26), a "for-profiteer" advocate claims to have called a settlement company to test this point and was instructed to do exactly that.

Ironically, but helpfully, the financial fallout for a consumer buying into this advice is documented by the American Fair Credit Council, the former name of the settlement industry's trade association. It commissioned a Harvard Kennedy School analysis of account records from 10 major settlement firms. The industry points to one statistic in the research that indicated that the first settlement closes in four to five months. But the industry avoids sharing the full picture its study developed. For example, the average debt settlement client seeks help with an average of seven accounts, and the average settlement for them takes 14.3 months. Worse, only 55% of client accounts were settled within three years, and a quarter of clients reached that three-year mark with no settlements at all.

More troubling, for-profit settlement firms push the same tactics to customers whose accounts are still current. TransUnion, using lender records against its national credit database, found 53% of clients were current on their bills the day they sought help. The result? Their median credit score fell 96 points. Meanwhile, those consumers who filed for bankruptcy saw their scores drop by only 20 points. In short, the product that claims to be a more fiscally responsible approach than bankruptcy performs worse than the alternative.

For-profit settlement advocates argue they are no different than creditors that settle debts. But creditors settle with customers who are in genuine default or are seriously delinquent, and they charge no fee. Compare that to for-profiteers who market and recruit solvent customers, instruct them to default, and then collect 15% to 25% of that debt. This is an industry that both manufactures and then profits from financial distress.

The for-profit settlement industry claims it is well regulated under the Federal Trade Commission's Telemarketing Sales Rule, which bars advance fees and permits payment only after results. But like so many of their claims, this is only partially accurate.

The rule polices when a company may charge a fee, but it does not cover debt settlement firms that routinely hold customers' savings, often thousands of dollars, with a promise to negotiate and settle their debts. AFSA's members answer to more than 20 federal laws and hundreds of state statutes before they can touch customers' money. Settlement companies do not.

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The rule fails to regulate a trend in the for-profit industry, carving out attorneys. A growing segment of the industry has built its corporate structure around a so-called "attorney model," branding themselves as law firms so the advance-fee ban does not apply, then collecting fees before aiding their clients.

But even when companies are covered by the rule, they break it. Regulators have brought a number of actions for violations. In 2024 the CFPB and seven state attorneys general alleged an attorney-model firm took more than $100 million in illegal upfront fees from struggling households, often without settling a debt. More recently the FTC warned military service members about debt relief scams aimed at them. Two federal watchdogs warning consumers from falling into debt-settlement traps is not what a well-regulated market looks like.

Finally, the rule, which was written in the era of call centers, doesn't account for how the debt settlement industry markets itself. Today's industry enrolls people on social media and by text message, creating another loophole, and highlighting why a legislative update is necessary.

The proposed Debt Settlement Consumer Disclosure Act provides that update. It accounts for today's marketing tactics, including on social media and mobile devices. It requires plain disclosure that the for-profit firms' products can ruin a consumer's credit. It requires a monthly statement for every enrolled debt, so consumers don't have to wait a year to see whether their settlement payments reached their creditors. And it bans use of advertising claims that firms cannot substantiate. None of these updates exist in current law, so one might think an industry claiming to already adhere to them wouldn't object to being held to them.

Yet they do, while also attacking nonprofit credit counseling services and claiming that Congress once found problems in the nonprofit sector. Congress did … and addressed those issues in 2006 by setting statutory standards for counseling nonprofits. As with their business model, they are willing to highlight the problem but fail to provide the solution. This is why AFSA supports an exemption for nonprofit counselors from the new bill, for a simple reason: They do not instruct anyone to default, and they collect nothing until creditors are paid.

If there is something positive to come out of this debate, it's this: a rare consensus amongst industries and organizations. Consumer advocates like the National Consumer Law Center, nonprofit counselors, and the lenders AFSA represents are rarely on the same side of an issue, but on better protecting consumers from for-profit settlement firms we agree. That should tell policymakers which side has the consumer's interest in mind and which side is simply defending their profit margin.