Time called on debt management company rip-offs

Some firms fail to tell debtors that there are fees involved, let alone that there are free alternatives. Chiara Cavaglieri and Julian Knight report

(JOE RAEDLE / GETTY IMAGES)

The debt management industry, worth an estimated £250m a year, is on the brink.

The Office of Fair Trading is threatening 129 out of 142 firms which, unless they improve the way they treat consumers, they will lose their credit licence – putting them out of business.

These companies have sprung up in recent years in direct response to Britain's personal debt crisis. Collectively we owe some £1.7trn – in mortgage, credit card and loan debt – and many of us can't pay this money back. That's where the debt management firms step in, offering individual voluntary arrangements (IVAs), debt management plans and negotiations with creditors, but all for a fee.

The OFT has found widespread malpractice in the industry. Some firms deceive consumers by failing to disclose that they charge a fee and implying that their services are free. In the worst cases, they are using "misleading or lookalike trading names purporting to be charitable or government organisations". In addition, some firms are cold-calling consumers to get them to sign up to their plans – against an agreement that the industry has with lenders. Other problems found by the OFT were incompetent advisers providing inadequate advice.

"People who are heavily indebted, desperate and vulnerable need advice which makes their problem better, not worse, and should not be exploited. Debt management firms must be clear about their charges and the options available to customers," says Ray Watson, the director of the OFT's Consumer Credit Group.

Paul, an engineer from the West Midlands, had an experience that was all too typical. He thought he would soon escape from debt when he replyied to an advert offering free debt advice. "The firm said I could be free from debt in five years if I agreed to one of their individual voluntary arrangements, which I understood to be a type of insolvency," he says.

"I agreed to their plan, but once I saw the personal budget they drew up for me I could see that I couldn't live on what they said I could. For one thing, it took no account of the costs of supporting my kids. I was also shocked at the fees they demanded – which equated to the first six months' repayments. It seemed as if they just wanted their pound of flesh. I'd never go for something like this again off the back of an advert."

Some in the debt management industry welcome the OFT's new get-tough approach. "Over the years, the commercial companies have grown and tend to be a bit lawless. However, this is a robust effort by the OFT and will bring in a lot of the cowboys," says Michael Land, the chairman of the Debt Managers Standards Association (Demsa).

But those in the debt management industry argue that they do fulfil a need, and that free-to-use bodies such as the Consumer Credit Counselling Service (CCCS), Citizens Advice Bureaux (CAB) and Money Advice Trust are inundated at present. Joanna Elson, the chief executive of the Money Advice Trust, says that although they are busy they can cope. "There are clearly some people who choose to pay for debt management services, and that is their right. However, we have evidence that others pay for these services simply because they are unaware of the free alternatives, or, indeed, did not understand that the provider they signed up with was a fee charger. We believe that all licensed debt management companies should be obliged to inform customers of free, independent alternatives."

Anyone who does decide that a debt management company is the only answer should ensure that they use a member of a trade association. Fortunately, this will cut out a huge swathe of less responsible companies as there are currently only 10 full members of Demsa, which is accredited with an OFT approved code. A further seven firms are undergoing the membership audit process. "We have a stringent audit; it takes about three months to get in," says Mr Land.

Debtors should also ask what fee structure is in place before taking the plunge. Typical charges to watch out for include an arrangement fee, a percentage fee for each payment and, finally, the debt management firm will also take a set number of payments for itself before paying off any creditors. The most unscrupulous companies may take as many as six payments before clearing any of the actual debt, leaving customers with an even bigger debt problem than they started with.

A major problem is that many companies make it virtually impossible to discover their fees, although the trade association members are much more transparent than others. Baines & Ernst, for example, charges a set-up fee of two monthly payments, an administration fee of £70, a monthly management fee equivalent to 17.6 per cent of each payment made to them, up to a maximum of £100.

Quite apart from the fees, debtors should remember that there is also no guarantee that using a debt management firm will work. They could end up paying through the nose for a service that hasn't worked. Creditors may not accept the proposal for reduced payments or frozen interest and are still free to take legal proceeding against their debtors whether a debt management plan is in place or not. The debtor's credit rating is also affected once the person is involved with a debt manager, which could affect their chances of being approved for credit later down the line.

"It is so important that those who are struggling with debt are offered services that are clear and transparent and advice that is independent and of the highest standards," says Delroy Corinaldi, external affairs director for the CCCS debt charity. "The review has found that this is often not the case within the fee-charging debt management sector."

Expert View

Joanna Elson, Money Advice Trust

There are clearly some people who choose to pay for debt management services, and that is their right. However, we have evidence that others pay for these services simply because they are unaware of the free alternatives, or indeed did not understand that the provider they signed up with was a fee charger. We believe that all licensed debt management companies should be obliged to inform customers of free, independent alternatives.