Pre-Paid Debt Settlement, Rest in Peace

One nearly dead, one dying fast. For consumers looking for low-cost ways to borrow money and get out of debt, the downfall of two entire industries may actually be good news, consumer advocates say.

The first lending industry on the ropes was tax anticipation loans. A series of regulatory changes could make 2011 the last year that companies can offer loans based on tax returns, which we covered here. Now the pre-paid debt settlement industry may be entering its final days, insiders say.

A rule imposed in October 2010 by the Federal Trade Commission banned companies from charging money up-front before doing any work to resolve a consumer’s outstanding debts.

[Resource: Tips for Paying Off Credit Card Debt]

That single rule change has caused membership in The Association of Settlement Companies (TASC) to plummet 70% in the last six months, says Eric Thompson, founder of Denver-based Prestige Financial Services, which switched from a pre-paid to pay-as-you-go model two years ago. Thompson began tracking the number of members listed on the TASC web site soon before the rule took effect.

While he didn’t confirm the exact numbers, Robert Linderman, vice president of TASC’s board of directors, says, “It’s a good approximation. And we don’t view that necessarily as a negative.”

According to Linderman, the huge reduction in TASC’s membership was partly due to the fact that the association now only accepts companies that follow the FTC’s rule by charging only after they actually resolve a debt.

“We want the industry to become much more respectable, to be recognized for the incredible value we provide to consumers,” says Linderman, who says the industry’s internal research finds that it resolved $1 billion worth of unpaid debts in 2010 and saved consumers between $400 and $500 million.

Some companies changed voluntarily, before the FTC rule took effect.

“We saw the writing on the wall,” says Thompson of Prestige Financial Services. He agrees with Linderman’s assessment about changes in the industry. “You’re taking delicate consumers and charging them money and not even providing a service. When you can eliminate that, I think it’s fantastic.”

[Resource: Consumer Guide to Debt Settlement]

Some companies continue to charge upfront fees by presenting themselves as attorney services, which are not covered under the FTC rule, says Gerri Detweiler, Credit.com’s credit expert. This is a dangerous bait-and-switch, Thompson says, since most companies use an attorney as a frontman but turn the debt reduction work itself over to non-attorneys.

“The industry is definitely being weeded out, and a lot of players who were relying on charging clients big upfront fees are gone,” Detweiler says. “That’s a good thing.”

Legitimate debt reduction services, which charge only after they succeed in reducing a consumer’s debt, still play an important role, Detweiler says. By working with so many consumers, they know which lenders are most willing to negotiate versus those most likely to sue. That’s important information that most people would never know, and it can help consumers know which debts they should settle first.

“And with the FTC rule, it gives the companies more incentive to screen for clients that are good candidates for settlement, so they’re more likely to only take on clients that can be successful,” Detweiler says.

A similar squeeze is hitting the tax anticipation loan industry now, as new regulations by the IRS, FDIC and the Office of Thrift Supervision make it increasingly difficult for companies like Jackson Hewitt and H&R Block to get the capital they need to offer loans, according to a recent report by the National Consumer Law Center and the Consumer Federation of America.

Image: quaziefoto, via Flickr