Phantom Debts Plague Collections System

Approximately one-third of Americans have debts in collection. But too many of those are calls for debts that are not in fact owed.

Though the exact number of such attempts is unclear, one Federal Trade Commission study's rough estimate was that debt buyers try to collect a million debts annually that consumers claim not to owe or owe in different amounts. A study of complaints to the Consumer Financial Protection Bureau reported that 42% of the consumer collection complainants charged that they were repeatedly dunned for debts they didn't owe.

This may happen for a variety of reasons. Because debt buyers don't make the loans in the first place — they buy the debts from the original lenders or other debt buyers — they rely on others for information about the debt. Unfortunately, just as in the game of telephone, sometimes something gets lost in translation. The debt sellers may also be at fault. For example, last year, one major credit card issuer agreed to pay about $200 million for a variety of problems, including selling unowed debts. Robo-signing also contributes.

One check on this problem is the federal Fair Debt Collection Practices Act: It obliges debt buyers to give consumers a validation notice which tells them of their right to dispute the debt and request that it be verified. But the validation notice helps only if consumers understand it, and considerable research in other contexts suggests that consumers often misunderstand or ignore disclosures. To make matters worse, because debt collectors are trying to get paid, they have an incentive to highlight their payment demands and downplay the validation notice. To combat this problem, the law states that collection activities can't overshadow the validation notice — but that may not always work.

To determine how effective the act's notice was, we conducted a survey of consumers (funded by the National Conference of Bankruptcy Judges Endowment for Education). We showed one group a collection letter that had been found sufficient by a federal court of appeals. We showed another set of consumers the same letter, but without the validation notice. Then we compared respondents' answers to questions about the validation notice.

The results were disappointing, unless you're a debt buyer. On most of our inquiries, respondents shown the letter with the validation notice did not perform significantly better than respondents who didn't see the notice. Roughly a quarter did not grasp that they could request verification of the debt, and nearly all who did mistakenly thought that an oral request would protect their rights: both the law and notice say a written request is required.

The sentence in the validation notice that read, "Unless you notify this office within 30 days after receiving this notice that you dispute the validity of this debt or any portion thereof, this office will assume this debt is valid" left many respondents mystified about when the collector would assume the debt to be valid. And the validation notice may actually have caused consumer confusion. For example, more than a fifth of the respondents thought that if they missed the 30-day deadline for disputing the debt specified in the validation notice, they would either have to pay the debt or would not be able to defend against a suit to collect it — even if they did not owe the debt.

One problem may be the difficulty of the notice. The court-approved version we used required three years of graduate school to understand, according to one widely used test of reading difficulty. In other words, even a college graduate with an MBA might not be up to the task. But when we tested a simpler notice, respondents showed only slight improvement, though perhaps other variations would achieve better results.

Unfortunately, courts evaluating validation notices have generally not taken real consumers into account. Instead, they rely on their own guesses about the adequacy of the notices. But judges conversant with the language of law are very different from consumers who may rarely encounter legal texts.

Happily, the CFPB is drafting regulations to implement the debt collection act's requirements. We may get a preview of what the bureau plans to do at its debt collection field hearing scheduled for July 28. We hope that the bureau will adopt rules that help consumers understand and use their rights. In the meantime, we urge courts evaluating whether collectors have complied with the statute's validation requirements to consider whether actual consumers get the message.

Jeff Sovern is a professor of law at St. John's University and co-coordinator of the Consumer Law and Policy Blog sponsored by Public Citizen. Kate Walton is an associate professor of psychology at St. John's University.