Claims of 'Becoming Debt-Free' Fall Flat for Consumers

DALLAS, July 24, 2009— -- In these troubled economic times, it seems as if it's impossible to turn on the radio without hearing an ad for debt settlement.

"We'll help you settle your debts for pennies on the dollar," the commercials promise.

There used to be about 20 debt settlement companies in the United States. There are now closer to 2,000. They sprang up after federal law changed, making it harder to qualify for bankruptcy, and they have proliferated in this down economy.

So "Nightline" wanted to know, what is debt settlement? How does it work? Is it a good choice for consumers?

To find out, we visited Credit Solutions of America, the largest debt settlement company in the country. At its Dallas-area headquarters, we saw employees ringing bells and cheering every time they persuaded a credit card company to settle somebody's debt for less than what they owed. When we visited with our cameras, the noise was deafening. But thousands of unhappy customers have complained about the company.

Customer's Case: Fees Without Settlement

Former customer Karen Moore said all she heard was silence. "I had absolutely no contact with them for over a year," Moore said. "And that was when I called them and told them I wanted to discontinue their service."

After having children and going through a divorce and moving two years ago Moore found herself deep in debt. That's when she saw something about Credit Solutions on TV. When she looked into it, the program sounded promising.

"You can likely become debt-free within three years or less," stated Credit Solutions on one of its videos. On its Web site, the company claims it can help clients reduce their debts by up to 50 percent of what they owe.

Moore signed up, and said that the first thing Credit Solutions told her to do was stop paying her credit card bills, which, according to a study by the National Consumer Law Center, is standard advice in the debt settlement world. Instead, Moore said the company told her to save a chunk of money that could be used to make an offer to the credit card companies to settle her debts once and for all.

But that savings account didn't accrue fast enough, Moore said, because, in the meantime, Credit Solutions was automatically deducting its own fee -- 15 percent of Moore's total debt -- from her account. In the first three months, the company deducted roughly a third of the fee from her bank account and then the ensuing balance over the course of the next 14 months.

Moore remained in the Credit Solutions program for 20 months, and paid the company's full 15 percent fee, yet Credit Solutions did not initiate a single debt settlement for her. And because she wasn't paying her credit card bills, the late fees and penalties piled up, causing her debt to soar from $13,000 to $18,000. Meanwhile, her credit score plunged.

"I'm out of pocket $2,088," Moore said. "And nothing to show for it." She said it's money she could not afford to lose given that she was in debt in the first place. "Absolutely not. Who can afford to lose money?" she said.

Former Customers File Class Action

Moore is one of many. Attorneys have filed a class action on behalf of potentially thousands of former customers who claim they were hounded by debt collectors and sued by creditors when they stopped paying their bills.

One former customer said when he sought the company's advice after he was sued, Credit Solutions sent him a list of ways to raise money, including "lend from church" and "sell plasma." The company now says that document was generated by an employee who wasn't authorized to create it at a time when Credit Solutions was under different ownership.

The Better Business Bureau of Dallas said complaints about Credit Solutions have remained consistent over the years, regardless of the ownership. The Better Business Bureau's Jeannette Kopko showed us a roughly 2-foot high stack of complaints about Credit Solutions.

"People all over the country, who are dissatisfied with the service they got," Kopko told us. "We've heard from 1,600 plus people in the past three years."

The Better Business said there's a pattern: people paying fees up front and then not getting their debts settled.

"There are people who say that they ended up in worse condition than before," Kopko said. "People who say they're veterans. There's someone who's a teacher, and she lost thousands of dollars to this company and had to get a second job."

Overall, the Better Business Bureau of Dallas said the entire debt settlement industry ranks near the top of industries consumers complain to it about.

Government Takes Action Against Debt Settlement Industry

Along with consumers, government watchdogs complain about the debt settlement industry -- including Credit Solutions. Texas Attorney General Greg Abbott filed suit against Credit Solutions March 26, accusing the company of "deceptive acts." On May 19, New York Attorney General Andrew Cuomo also sued Credit Solutions, launching an investigation of the entire debt settlement industry. And May 28, Missouri Attorney General Chris Koster piled on, accusing Credit Solutions of fraud.

Credit Solutions blames its legal troubles on a one-year period from December 2006 to December 2007, during which the company was under different ownership.

"There is a period of over a year that we have been working diligently to clean up," Vice President of Operations Heather Carmichael told us. "Our founder bought this company back at great personal cost, making a commitment to the employees and to our customers to keep our promises to customer service."

But Matt Reivitt, who ran the company in the interim, said that "existing problems within the company were deep and ingrained."

And all three attorneys generals said their lawsuits cover a period of time when the current CEO, Doug Van Arsdale, was running the company. We had an interview scheduled with Van Arsdale, but he backed out at the last minute, sending Carmichael instead.

Credit Solutions Responds to ABC News

We asked Carmichael to respond to the fact that three separate attorneys general are suing Credit Solutions.

"I wish there was an easy answer to that question," she said. "The industry is changing so rapidly. And there is more change to come."

Carmichael declined to comment further on the pending litigation except to say, "I can tell you that we are working diligently with them toward an acceptable solution."

"Nightline" asked Carmichael if she could tell us what percentage of clients pay their fees without having their debt settled by Credit Solutions.

"That's a great question. I don't have that number, but I can certainly look at it for you," she told us.

Carmichael never did get back to us with that answer. But New York Attorney General Andrew Cuomo said Credit Solutions settles debts for only 1 percent of its customers in his state.

Carmichael defended Credit Solutions, saying, "We have a proven track record of success, and hundreds of thousands of people who have successfully completed our program."

We also asked Carmichael about an internal sales script "Nightline" obtained. Two former employees told ABC News it instructed salespeople to tell customers "what we'll do is reduce your debt down to 50 percent of the original amount."

Carmichael replied, "I wish I could respond to that. I haven't seen the script you're referring to." When asked if it would trouble her if such a script was used, she said, "Absolutely."

Several states limit advance fees for credit services to $25 to $75. In Missouri, it's illegal to charge any fee in advance, according to the attorney general's lawsuit.

When we asked Carmichael why Credit Solutions began charging its fees the first month, before settling any debts for the customer, she said, "This is an ongoing coaching. So we become your financial advocate and your coach. ... And if you look at many other industries, they work the same way. We are a big part of the solution for many consumers out there."

But Karen Moore said the company was far from a solution for her. She's been demanding a full refund for months, so "Nightline" inquired about her case. Her refund finally showed up the day we visited to interview her. Moore said she now hoped to approach her credit card companies on her own to see if she could settle some of her debts.

Settling Your Debts on Your Own

Some consumers have had success approaching their credit card companies directly and offering settlements for less than the total amount they owe. There are signs that more credit card companies are accepting these offers in this recession economy in order to get something now rather than nothing later.

Some banks have been approaching consumers themselves, offering settlements of up to 70 percent off the amount owed.

But beware: When your credit card company agrees to accept a lesser amount, it counts the partial payment as a "charge-off," a black mark that remains on your credit report for seven years. A charge-off can cause your credit score to plunge by 100 points or more.

Credit experts advise only taking this step if your credit score is already ruined and you have no other viable options. Also keep in mind the ripple effect: When your credit score drops, other banks you have accounts with will see you as a higher risk and may drop you or raise your interest rates with them.

One less-drastic alternative is to try to negotiate with your card company to lower your interest rate and drop any fees and penalties that have accrued, rather than reducing the actual principal owed.

There's another lesser-known risk to settling your debts: The card company may report the amount forgiven to the IRS as income you have earned. You will then have to pay income tax on that amount, reducing the cash benefit of your settlement.