FTC Bans Upfront Fees by Debt Negotiators

The FTC enacted a new rule, effective October 27, 2010, that will ban debt negotiators from collecting an advance fee before the debt has been negotiated.

This is a serious problem, as I have commented before on this blog. It has been said that the business of most debt negotiation companies is akin to a Ponzi scheme, because it essentially requires failure of the debt negotiation plan for the debt negotiation company to be most profitable. Most of these companies require payment of almost all of the fee upfront. So, for example, the total debt might be $40,000, monthly payment for 36 months might be $500, and the debt negotiation fee might be $4,500. But almost all of that fee would be taken in the first 9 months and then the debt negotiation would start. By that time, at least one of the creditors will have sued and the plan will fall apart. Most of the time the debtor will end up filing bankruptcy, having obtained no real benefit from the debt negotiation plan.

In addition, the rule will provide how much of the fee can be collected for each debt that is settled:

To ensure that debt relief providers do not front-load their fees if a
consumer has enrolled multiple debts in one debt relief program, the
Final Rule specifies how debt relief providers can collect their fee
for each settled debt. First, the provider's fee for a single debt must
be in proportion to the total fee that would be charged if all of the
debts had been settled. Alternatively, if the provider bases its fee on
the percentage of what the consumer saves as result of using its
services, the percentage charged must be the same for each of the
consumer's debts.

I do not think that the current business model used by most of the debt negotiation companies out there will work with these rules. So, we will either see a lot of companies get out of the business or they will be using a different business model, one that actually serves the clients. That being said, I would not be surprised to see a lot of companies try to operate while ignoring this rule.