With hard times here and revolving-credit debt in the U.S. reaching just short of a trillion dollars, companies that offer consumers a chance to reduce or even eliminate credit card debt through debt management plans are proliferating.
But for anyone facing a pile of bills they simply can’t pay, it’s important to ask whether these companies have the best interest of their clients at heart.
Debt management, or debt settlement, companies typically charge several thousand dollars in fees, says Charles J. Phelan, president and founder of Zip-Debt.
“That fee is stacked up in the first 12 months or so of your payments to them,” Phelan says. “So nothing gets settled in the first year, and that greatly increases the risk of legal action.”
“One thing you absolutely want to avoid is a debt elimination program,” warns Gerri Detweiler, founder of Ultimate Credit Solutions Inc. and co-author of the forthcoming “Stop Debt Collectors: How to Protect Your Rights and Resolve Your Debts.”
“They claim there are legal ways to wiggle out of your debt and pay nothing, then charge large fees to erase your debt. Credit card debt is not illegal, and you cannot pay someone to erase it.”
Debt counselors say that with patience and determination it’s possible to strike deals with your creditors yourself.
“Debt settlement, like the law, is a service-based business,” says Jeff Boulton, CEO of RiseAboveDebtRelief.com. “You can represent yourself in court, and you can settle with your creditors yourself.”
When settling makes sense
Debt settlement is not for everyone, but it can be a good solution if your only other option is Chapter 13 bankruptcy.
“I recommend that anyone thinking about debt settlement talk to a bankruptcy attorney to see what their options are, especially if they owe more than $10,000,” Detweiler says. “If you do qualify under the new rules to do a Chapter 7 bankruptcy, that could make more sense.”
Changes in the bankruptcy law in 2005 made it difficult for many people to file for Chapter 7 bankruptcy, which liquidates debts. If you have regular income and there is some leftover after you pay basic expenses, then you must go to Chapter 13 bankruptcy, which requires that you pay back some or all of what you owe over five years under a very rigid payment structure, says Phelan, who calls Chapter 13 “the worst of both worlds.”
“If you have a lot of unsecured debts,” Detweiler warns, “then you’re probably better off getting help from an outside source who can help you prioritize and deal with some of the more aggressive ones. But anyone with up to three creditors can certainly try to settle with them directly.”
You want to know what information your creditors are looking at, Detweiler says, so before you try to resolve a debt, get copies of your credit report from all three major credit bureaus: Experian (www.experian.com), TransUnion (www.transunion.com) and Equifax (www.equifax.com).
Then stop paying creditors and start stashing money away in a separate savings account.
That’s necessary because you can’t settle a debt unless you have something to offer.
“To make it work,” says Phelan, “you will need some money to settle with. Most people use a combination of monthly savings, tax refunds, proceeds from selling a vehicle, borrowing against a 401(k) on a hardship basis, or whatever help they can get from a family member.”
Make an inventory of all your debts and write a budget to see how much you can realistically afford to pay to avoid being pressured into a settlement you can’t meet, Detweiler says.
Phelan suggests having caller ID or some other call screening in place to cut down on harassment by phone.
The first phase of the collection process begins from the due date of the first missed payment, he says. “If you don’t make any further payments, the clock is ticking up to the charge-off — the point in time when the creditor formally takes the loss off their books.
“Up to that point, you are still dealing with the original creditor — normally a bank’s own in-house employees.”
While you’re unlikely to negotiate a good settlement in the early days of this first phase, it’s a good idea to establish contact.
“I am not a fan of ignoring your creditors or collectors,” Detweiler says. “Sometimes that can force them to become more aggressive. If you’re having trouble making payment, let them know, but indicate what you think you can pay, and when. Talk amounts, not percentages.
“If they try to pressure you into paying something right away, tell them, ‘I’m sorry, I can’t afford it,'” she advises. “If they persist, you may have to say, ‘I will bring you up to date in a month,’ and hang up the phone.
“Keep good written notes of any conversations you have with creditors — who you spoke with, when you spoke and what was agreed.”
“You need to step up and communicate,” Phelan says, “because this is what gets the job done. It’s going to take a series of conversations. Tell them you’re aiming to avoid a bankruptcy and would like to work something out. In the early months there will not be a lot of willingness, but if you persist, repeating this almost mechanically, eventually they will start talking settlement.”
Very often in this early stage, says Boulton, the creditor will say they don’t do settlements and suggest a payment plan instead.
“Don’t take no for an answer,” he counsels. “Let them know they can take what you’re offering or they won’t get anything. Tell them, ‘The negotiation is there and it is available, but I have other creditors and if they settle first, you will be out.'”
Negotiating the settlement
Credit counselors agree that really good settlements start towards the end of this first phase of the collection process, with the maximum just before the charge-off, when it makes sense for the original creditor to cut their loss.
“Normally after the six-month mark the creditor turns the account over to a collection agency,” Phelan says, “or sells the debt to a third-party agency. That begins the second phase of the collection process.”
These third-party collectors, he says, work on contingency. “They get paid by doing deals, and settlements are normal. It’s just a business deal.”
This phase can go on indefinitely, Phelan says, though many sell the account to a debt purchaser sometime in the second year.
But he says it’s a good idea to settle within 12-18 months if possible. The longer you wait, the higher the risk that the creditor will decide to litigate.
If your debt is more than $10,000, Detweiler says, “It becomes more worthwhile for a creditor to take legal action.
“If you completely stop communicating with them — change your phone number, stop taking calls — that’s also putting yourself at risk of a lawsuit, because you leave them with no other option.”
“But they don’t usually act quickly to sue you, because it will be more expensive for them, and even if they get a judgment against you, it can be very difficult for them to collect.”
Different creditors have different guidelines, she says, “but in the overall scheme of things most consumers who work with professional debt settlers end up settling all their debts for about 50 to 60 cents on the dollar. It’s a question of how likely the creditor thinks they are to get anything out of you.”
Once a creditor agrees to a settlement, get it in writing, says Boulton.
“This is where a lot of consumers make a mistake,” he says. “The creditor will say, ‘OK, but you need to pay us today.’ Then that amount actually goes towards interest. So before you pay anything, get the settlement offer in writing on the company’s letterhead — and another letter stating that the payment has been made, and the debt is discharged.”
Without that proof, says Detweiler, the forgiven balance could end up with another collection agency.
“I don’t recommend letting them take out an automatic bank draft,” she adds. “A bank check is preferable.”
No way around it — settling your debts is going to hurt your credit score. But if you’re unable to meet your payments, Boulton says, your credit standing is already negatively affected. If your only other option is bankruptcy, damage to your credit is inevitable.
“Creditworthiness has two components,” Phelan points out, “debt-income ratio and credit score. So yes, your credit score will go to the subbasement. But as soon as you settle your debt, your debt-income ratio will vastly increase. So your credit rating can return to reasonably good shape within about two years.”
Taxes are another concern, he says. A creditor who forgives a debt of $600 or greater must issue a 1099C form that is counted as taxable income.
But, the IRS allows an insolvency exemption, Phelan says.
“The purpose of a debt-settlement program is not to walk away from the obligation,” he says, “but to work out a mutually agreeable settlement. If you go about it with a spirit of good faith, you can come to a workable compromise you can both live with.”