Accusations of shady practices are on the rise. Here are five ways credit counselors take advantage of their customers.

THE SALES PITCH is seductive: For a small monthly fee, a credit counselor will negotiate with a person's creditors to reduce or eliminate interest charges, consolidate the person's debts into one low monthly payment and handle all of the transactions.

The trouble is, many credit counselors are outright crooks, using deceptive tactics to separate debt-plagued consumers from their money. And, increasingly, they're succeeding.

The credit-counseling industry has helped millions of consumers pay off their debts since the 1950s. But during the past few years, there has been a startling spike in the number of claims of abusive practices. From 1999 to 2003, complaints filed annually with the Better Business Bureau increased by 590%, from 1,140 to 7,862. "And that's just the tip of the iceberg," says Travis Plunkett, legislative director at the Consumer Federation of America.

The number of rogue counselors preying on overextended Americans is soaring, say experts. Some are collecting consumers' payments and failing to distribute them to creditors, while others are neglecting to disclose their sometimes hefty fees. Increasingly, agencies are also enrolling people in one-size-fits-all debt-management plans with no regard for their unique financial situations. "There are so many (companies) just trying to rape the industry (by) not doing the right thing for the customer," says Jack Marcus, president of A Better Way Credit Counseling and one of the leading lobbyists for imposing stricter regulations on the industry.

The problem has become so pervasive that the federal government has gotten involved. Several weeks ago, Congress held a hearing on credit-counseling abuses, soliciting testimony from burned consumers and employees of companies that allegedly engage in abusive practices. The Federal Trade Commission, meanwhile, is investigating an undisclosed number of companies, according to FTC staff attorney Bethany Matz. And the IRS is auditing the 50 largest companies and has tightened the rules for granting nonprofit status. Some state governments have filed class-action lawsuits against certain companies as well.

That's not to say that the entire industry is corrupt. Many credit counselors provide valuable services for reasonable fees. (For more on that, read our story "Help! I'm Drowning in Debt.") But the reputable agencies are seeing their reputations sullied by the bad players, says Lydia Sermons-Ward, spokeswoman for the National Foundation for Credit Counseling (NFCC).

What do consumers need to watch out for? Here are five warning signs that a credit counselor might not have customers' best interests in mind.

1. Fees, Fees, Fees
Fees are one of the biggest problems in the credit-counseling industry. Many companies charge monthly fees that run as high as 10% of customers' payments, or fail to disclose to consumers that their first payment will be retained as an enrollment charge.

Consider what happened to Raymond Schuck, a retired museum director from Lima, Ohio, and one of the consumers who testified at the Congressional hearing in March. He enrolled in a debt-management plan with Massachusetts-based Cambridge Credit Counseling in 2001 to pay off about $90,000 of credit-card debt. Cambridge told him that he would be charged a 10% monthly fee on his payments of $1,946 a month, but allegedly failed to disclose that his first payment would stay with the agency. "Had I known this policy in advance, I would have searched for a different credit-counseling agency," Schuck testified. "I would not have agreed to give Cambridge $2,000 when that money could have gone to my creditors."

In a press release issued on the day of the hearing, the company said that "all fees charged by Cambridge Credit are fair and reasonable and fully disclosed to consumers" and fall within the range of other credit-counseling agencies that are members of the NFCC.

The lesson here, however, is that consumers need to fully understand the fees involved before signing up with a credit counselor. "We advise consumers to ask the agency to put the fees in writing," says the FTC's Matz. Some states have started to impose caps on the fees that agencies can charge each month.

  Agency Research Do's
1. Search the Better Business Bureau database for a company's records.

2. Call the state Attorney General's office to check for previous complaints against the company.

3. Check with the local Chamber of Commerce.

4. Report industry abuses to the Federal Trade Commission.

  Agency Research Don'ts
1. Don't sign a contract before you've received a detailed proposal from the agency with a clearly defined fee structure.

2. Don't go with an agency that pressures you into a debt-management plan right away. Traditional credit-counseling agencies spend an hour or more with a client before they advise on a DMP.

3. Don't give out your bank-account information to any agency before you've signed a contract.

2. Pushing Plans on People Who Don't Need Them
Some agencies enroll people in debt-management plans without discussing other options (like perhaps a reverse mortgage) that may be a better choice. "That's a sign that the agency doesn't have the consumer's best interest at heart," says Matz.

Fact is, debt-management plans are money makers for credit counselors, which means there's a financial incentive to sign people up. In testimony before Congress, former Cambridge Credit Counseling employee John Pohlman described the agency's office as a "boiler room." An electronic board at the front of the room displayed the names of the counselors who had the top sales for the month in red and yellow lights. The refrigerator in the lunch room, on the other hand, posted a sign reading "The two lowest producing counselors will be cleaning the refrigerator on Saturdays."

John Paul Allen, who worked at AmeriDebt, a Maryland-based credit-counseling company also under investigation, testified: "The goal for AmeriDebt's counselors was to sell consumers a debt-management plan regardless of whether they needed it or not." He was told that each call with a potential customer was to take no longer than 15 minutes.

AmeriDebt chose not to comment. But Montieth Illingworth, a corporate spokesman for Cambridge Credit Counseling, said that Pohlman was "factually not correct, and I would question the truthfulness of his testimony, even under oath." According to Illingworth, Cambridge rewards its employees for retaining customers in the program, not enrolling them. Illingworth also pointed out that Pohlman had worked at the company for only six days.

In any case, this practice has become too common in the credit-counseling industry, says Steve Rhode, founder of MyVesta, a former credit-counseling agency that now provides only educational services. "It's all about enrolling people in debt-management plans because that's the only product they have that they make money on."

That's partly because many credit-card companies have significantly decreased their support for the industry, explains Marcus. "Years ago, they used to give us a fair-share contribution, which is their way of backing us for collecting their money for them," he says. "They used to give us 15% at one time, (but) they're now doing an average of about 6%, and a lot of times they don't give us anything."

With creditors limiting their fair-share contributions, and state governments capping the fees that counseling companies can charge for their services, they have no other way to get revenue but through volume, Rhode explains.

That's not the case for companies that are members of the NFCC, says the foundation's spokeswoman Sermons-Ward. In response to limited funding from the creditors, the NFCC is now getting more of its income through government grants and donations from charitable institutions like the United Way, she says.

3. Using the Ol' Bait 'n Switch
All too often, the low monthly payment that's initially promised by a credit counselor is raised once a consumer has made a couple of payments. "A lot of companies will lower the payment to get you into the program, and once you enter they tell you the creditors want a higher payment," says Marcus.

That's unfair, since the amount a creditor will approve for repayment typically isn't flexible. Even though agencies often promise to "negotiate with your creditors," each creditor has preset guidelines for debt-management programs. Chase, for example, wants a minimum 2% payment of the balance a month and will lower the interest rate to 7%, Marcus says. Another creditor may want 4% of the balance each month, and so on. So there's actually no room for negotiations based on the individual's particular situation.

"All credit-counseling agencies have the exact same guidelines (for each creditor)," says Marcus. In other words, if the payment proposed by one company is significantly lower than that offered by the other, and the reason isn't the fees, that could be a red flag that the company is low-balling just to sign up a customer.

4. Pressuring You to Sign a Contract Upfront
No matter what, don't sign a contract with a credit counselor until all the details -- specifically the repayment terms and any fees -- are clearly spelled out. In their rush for new business, some credit counselors will encourage potential customers to sign on the dotted line before these details are solidified. That, obviously, could create big problems in the future.

5. The Company Has Close Ties to For-Profit Organizations
The credit-counseling industry was established as a not-for-profit industry -- and consumers have come to implicitly trust companies that have not-for-profit status. Schuck, for example, who lost $2,000 to Cambridge Credit Counseling, said he "made the naïve assumption that because it was a nonprofit agency, I could trust them."

Many of these nonprofit companies are tied to for-profit firms. Cambridge Credit Counseling, for example, faces a class-action lawsuit in Maryland on allegations that it has funneled more than $60 million to for-profit companies owned by company insiders. Cambridge is also under IRS investigation.

Funneling cash to for-profit companies not only betrays people's trust, but hurts their pocketbooks as well. "(For-profit) companies are sort of laundering money through a nonprofit shell," says the CFA's Plunkett. "And it looks like a lot of money is being funneled from consumers in the way of fees, straight through this nonprofit shell to for-profit vendors."

Figuring out whether a nonprofit firm has for-profit ties is no easy task. First, consumers should pull the company's tax return, or Form 990, from GuideStar, an online database of nonprofit organizations. The form should list the top vendors with which the company does business. Then consumers should check the companies' business filings with the Secretary of State, which should list chief officers and directors, and see if any of the names appear on more than one company's record.

Don't forget, this is only one red flag -- by itself, it doesn't necessarily point to any wrongdoing, says Plunkett. "You've got to look at the whole picture," he says. Is the company offering education classes, or is it merely a collections agency for the creditors? Plunkett also advises consumers to check with the Better Business Bureau and the state Attorney General's office for complaints or ongoing investigations against the company in question.