Companies promising to help borrowers reduce or eliminate their debt have proliferated in the economic downturn. Under a new regulation that goes into effect Wednesday, these debt settlement companies will no longer be allowed to collect upfront fees from customers. They will have to first successfully reduce, settle or renegotiate a debt.

The Background

The new regulations come after a surge in consumer complaints about the industry. In complaints filed with the Better Business Bureau customers said they paid steep upfront fees, usually a percentage of the amount they owed, but that their debt was never reduced. Some ended up deeper in the hole or were sued by creditors because interest or late charges piled up as they waited to renegotiate their debt.

Other Regulations

The ban on upfront fees is the second and final phase of regulations adopted earlier this year. The first round, which went into effect a month ago, requires companies to disclose certain information upfront, such as how long the process will take and how much it will cost.

Customers are also sometimes required to start setting aside money to pay off any remaining debt in a separate account maintained by the debt settlement company. These accounts must now be maintained at an independent financial institution under the customer's name.

What to Watch

The Federal Trade Commission's new regulations apply to companies that sell services over the phone. The rules do not apply if the initial contact with the client is in-person or if the services are rendered entirely online. But the FTC says most of the industry will be covered because companies typically advertise a phone number in TV and radio ads for customers to call.

As an alternative, the Better Business Bureau suggests borrowers first try contacting lenders directly to negotiate debt. Borrowers can also seek help from nonprofit credit counseling centers, which typically charge small fees for help managing debt.

The National Foundation for Credit Counseling enables borrowers to find local counselors.

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