Credit Counseling Can Cause More Ills

Melinda Meyer learned about the dangers of unscrupulous credit counseling organizations the hard way.

Heavily in debt and faced with losing her job at a local TV production company, she contracted with a credit management firm that promised to drastically reduce her debt. Eight months and about $2,800 in payments later, Meyer’s debt has ballooned and her credit rating has been savaged. She’s now trying to undo the damage.

“This has just fouled me up completely,� said the Los Angeles resident, who recently started a dog-walking business. “I’m 36 years old. I want to buy a house and do things in my life, but I’m at a point where I don’t even want to look at my credit card statements. How do I get out of this?�

Stories like Meyer’s have become so common that a coalition of federal and state regulators issued a rare warning last week: Beware of nonprofit debt counseling services that may be using the special tax status granted to charities simply to get around consumer protection laws.

Credit counseling services traditionally have sought to educate consumers about how to manage credit and deal with debt. However, as Americans sank further into debt in recent years, a number of firms sprang up that promised a quick fix to credit woes.

Some of these firms help consumers get Social Security or tax identification numbers to simply obscure past credit problems; others offer to negotiate deals with creditors to cut debt payments -- a promise that rarely works out as advertised.

A federal law passed in 1997 was supposed to protect consumers from abusive credit counseling services, said David J. Vendler, a Los Angeles attorney who has filed a class-action suit against one national credit counseling firm.

The law requires credit counselors to provide potential clients with a host of disclosures, including one that explains that debt-laden consumers can negotiate directly with their creditors instead of hiring a company to negotiate for them. Several state laws mirror the federal regulation, and some even restrict the fees that can be charged by credit repair organizations.

But the federal law and many of the state laws exempt nonprofit groups, Vendler said. Many debt management firms began calling the fees paid by their customers “donations� and applied to the Internal Revenue Service for nonprofit status, allowing them to skirt the requirements of the federal law.

“It is not fair to taxpayers struggling with financial problems to be taken advantage of by credit counseling groups exploiting gaps in the law,� IRS Commissioner Mark W. Everson said in a statement.

The IRS is trying to crack down on bogus nonprofits, said Lois Lerner, director of the agency’s exempt organizations division. But it often is difficult to tell which credit counseling agencies are legitimate and which are not.

Credit counseling agencies can be legitimate nonprofits because counseling poor people on ways to better manage money is a valid charitable purpose. But to be a legitimate charity, the company must operate for the good of the community, not for the benefit of the company’s management or organizers.

The IRS couldn’t say how many applications for nonprofit status it had received from the credit counseling industry in recent years. However, industry experts maintain that the field has become overrun by abusive operators in the last few years.

“The self-dealing is rampant. It has ruined our business,� said Dianne Wilkman, chief executive of Springboard, a Riverside-based credit counseling service. (Springboard is one of only two credit counseling services in the Los Angeles area that are recommended by the Better Business Bureau. Several dozen others have “unsatisfactory� ratings, said Lona Luckett, senior trade practice consultant at the BBB in Colton.)

“We welcome the IRS crackdown because all get painted by the same brush,� Wilkman added. “We are glad this is happening. It’s about time.�

What happened in Meyer’s case is typical of how abusive credit counseling firms work, said Peter Lake, chief executive of Consumer Credit Counseling Service of Los Angeles.

Legitimate credit counseling firms will sit down with clients, examine their finances and recommend a course of action. Only about 30% of CCCS customers are put on debt repayment plans by the agency, Lake said. The other 70% fall into two categories: people who can work out their debt on their own with a little advice and those whose debt woes are so severe that they need to file for bankruptcy protection.

But unscrupulous debt-management mills want to put all their clients on debt payment plans so they can collect so-called fair-share payments from creditors and debt management fees from clients, Lake said. These firms often do more harm than good for their customers by persuading them to let their bills become delinquent and then negotiating settlements that savage the consumer’s credit rating -- if a settlement is made at all.

Although Meyer was heavily in debt, she had a good credit record because she had never missed a payment. She sought counseling from a debt management service because she was about to lose her job.

“I wanted to be responsible and deal with this early,� she said.

But according to Meyer, instead of contacting her creditors as the firm promised, the firm collected Meyer’s monthly payments and let her accounts go into default. By the time Meyer realized what had happened, the $19,000 she owed to five credit card companies had soared to more than $26,000 from accrued interest, late payment and over-limit fees. Now working for herself, she’s attempting to settle directly with the creditors and is considering suing the debt management company.

“Consumers who are struggling financially need to be careful not to lose even more money to someone offering a quick and easy way to fix credit problems,� said Timothy J. Muris, chairman of the Federal Trade Commission. “We want all consumers seeking help to take some common-sense precautions.�

Among the FTC’s recommendations:

* Check with a local Better Business Bureau for ratings on debt management companies you are considering.

* Read contracts carefully. Many of the bogus debt management firms require “donations� that amount to the consumer’s entire first monthly payment -- an amount that can worsen consumer debt loads and is often against state law.

* Find out whether the credit counseling firm is a member of the National Foundation for Consumer Credit or the Assn. for Independent Credit Counseling Agencies. Both groups impose “best practices� standards on members that steer them away from abusive activities.

* Report abuses. Those who suspect they’ve been misled should contact the Better Business Bureau and the Federal Trade Commission at www.ftc.gov. If the counseling agency has purported to be a nonprofit, also report it to the IRS Exempt Organizations examination division at 1100 Commerce St., MC 4900 DAL, Dallas, TX 75242.

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Times staff writer Kathy M. Kristof, author of “Investing 101â€� and “Taming the Tuition Tiger,â€� welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail [email protected]. For past Personal Finance columns, visit The Times’ Web site at www.latimes.com/perfin.