Avoiding the Mistake of Debt Settlement and Debt Consolidation Companies
“The only man who sticks closer to you in adversity than a friend is a creditor.”
Let’s Clear the Air with a few Definitions
Debt Settlement Company- Offers, for a fee, to renegotiate some of your debts, collect a single payment from you, and pay your debts.
Debt Relief Company—Same as Above, Debt Settlement Company.
Debt Consolidation Company— Combine and wrap up all of your unsecured debts into a new loan.
Debt Collection Company—Hired by lenders and creditors to collect an unpaid debt from you.
Debt Settlement/Relief Companies
Who are the companies advertising on the radio and late-night TV promising to reduce or remove your credit card debt? Are they legitimate companies designed to create a debt repayment plan suitable to your situation? These companies appear to provide a legitimate solution to solve your debt problem.
Most are scams eager to take what little money you have left. The advertising implies that you will eliminate your credit card debt with little or no consequences. This is simply not true. Most debt relief customers do not complete their program. Debt settlement companies charge you a fee for their service anywhere from 15 to 20% of your debt. So, starting with, you end up paying 15-20% more than you owe. They claim they lower your interest rate, there are no tax implications, and they offer affordable solutions. Unfortunately, this is not true.
Unsavory debt settlement companies often tell their customers to stop paying your debt and instead pay your payments to the settlement company. Once they have collected their fee, they disappear, leaving you dealing with your creditors. Your debt is now higher because of late fees and penalties. Debt settlement companies are scams.
Debt settlement/relief companies create a debt repayment plan and you pay one monthly payment deposited in a savings account the debt relief company charges you for. They pay your bills. These programs deliberately default on your debt to secure a better chance of negotiating the balance you owe lower. Unfortunately, that wrecks your credit. The debt relief company then contacts your creditors after you have defaulted on your debt. The debt relief company then tells your creditor that you are one step away from bankruptcy and it would be better if the creditor settled for a smaller dollar amount than accept nothing if you declare bankruptcy. The debt relief company keeps 20-25% of your debt as payment. This is besides the fees charged.
Don’t fall for these scams.
Debt Buyers and Settlement companies made over 3.5 billion dollars last year settling debt. As an example of the close relationship between debt settlement companies and debt collectors, I mention Encore Capital. It is a publicly traded company that combines debt collection and debt settlement within the same company. Why is that not a conflict of interest? It may be, but this business model is legal. Debt collection companies use computer generated behavioral and statistical data (decision science) to decide if you are a suitable candidate for paying your bad debt! This means they are looking for consumers who can stay afloat with as much debt as possible on their backs. Debt settlement companies consider these the best customers for debt settlement companies. When you cannot meet your agreements with the debt settlement company, they just send your file to the next hallway, debt collections. I implore you to stay away from too much debt, debt settlement companies and Debt Collectors.
When should you seek debt settlement/relief?
· Seek bankruptcy when it appears you cannot pay off your unsecured debt (credit cards, personal loans, and medical bills) within the next five years.
· The total of your unsecured debt equals 50% or more of your gross income.
You should seek advice from an attorney. I do not provide legal advice in this book.
Instead, connect with the Financial Counseling Association of America or the National Foundation for Credit Counseling. These are legitimate financial educators providing credit, bankruptcy, housing, and Student Loan Counseling for free or at low cost.
What should you know about Debt Consolidation Companies?
Debt consolidation companies wrap most of your unsecured debt (credit cards, personal loans, payday loans, medical bills) into a single loan. The debt consolidation company promises a lower payment. This may be true, but they depend upon your financial ignorance to get you a lower payment by extending the term or the length of the loan. Let’s say you have $10,000 in combined credit card and personal loan debt. The payment total is $361. The debt consolidation company charges 9% interest and refinances your debt for 5 years. Your new payment is $207. A savings of $150 per month. Here is what they forget to tell you. Instead of being paid off and debt free in three years, you will pay the lower payment for an extra two years. The good news, in this situation, is you will save interest charges.
You do not need a Debt Consolidation Company
Debt consolidation is a strategy you can employ on your own. You can combine your credit card payments, personal loans, and any other high interest rate loans into one simple loan. The idea is to have one easy payment at a lower interest rate. The combination of loans results in an overall lower payment. Another possibility if you are a is to open a HELOC or Home Equity Line of Credit at a very low interest rate if you own your home and you have equity to borrow against. The “only” problem with this method is that you are using your home equity as an ATM. This became a hobby for millions of Americans in the early to middle 2000s and was a major contributor to the financial crisis of 2007-2008. You are putting your home at risk to reconfigure your debt. That could be a very good thing, or a terrible thing. It depends if you can manage your expenses. If you pay off your high interest credit card debt with your new debt consolidation loan, and then celebrate by using your credit card again on unnecessary wants to fill up your garage, or go on a trip to Bermuda, then you are making a poor decision. I call this “credit creep”. The credit card in your pocket with a 0 balance is itching to buy more stuff. If you have the discipline to cut the card, not close the account, and spend no more (online), then this may be a solution. I hope you have the discipline to pay off your unsecured debt in full and stop borrowing from your credit card again? Learn to enjoy your new found debt-consolidated life. Put any extra money you make into paying more on your debt consolidation loan.
Check out this calculator to see if consolidation from many cards to one card makes sense.
Another choice is to open a new credit card account with a 0% balance transfer card[AS2] . The lender may not charge you a balance transfer fee. I prefer doing business with a credit union. They charge lower interest rates besides having 0 balance transfer plans. Transfer any expensive (high interest rate debt) to your new “0” balance low interest rate transfer card. This only makes sense if you can repay the debt before the promotional period expires. If you don’t repay the debt before the promotional period ends, you will be obligated to pay all the accumulated interest from the day you transferred the debt. That is expensive! You must have the discipline to stop using the card to buy unnecessary wants.
Debt Management Companies
You may consider a nonprofit debt management company. Debt management companies normally charge a monthly fee around $30.00 per month[KR4] . The debt management solution dedicates a person to pay your debts. You send them a single check and they pay your bills. They may renegotiate better interest rates. A debt management system can take three to five years to carry out. Look for these reliable, low fee, debt management companies in most cities described as Credit Counseling Agencies. Most are nonprofit.
What are the alternatives to Debt Settlement/Relief?
1) Negotiate a lump sum to pay the debt in full with your creditor. Negotiate on your behalf. You will need confidence to succeed at negotiation. If not, consider hiring a credit counselor to help negotiate for you. Settling for 40% to 50% of what you owe is realistic. Again, you may have to pay taxes on any forgiven debt above $600. In addition, negotiate how the debt agreement is reported on your credit report! Credit Report “Accounts” are called Tradelines. The rating you are looking for is “Paid as agreed”. When you make the call, it is imperative you keep your emotions in check and be patient. It may take more than one call and more than one associate before you get a reasonable agreement. Don’t forget to ask for a supervisor. Make sure you have an accurate financial hardship story ready for the call. If you can realistically pay 50% then start the negotiations below 50%. If you start at 50% there is no “wiggle” room. After you agree, it is imperative to agree in writing. Make sure the terms and conditions are understandable, including how the debt is reported to your credit bureau. Don’t default on your new agreement. If you, “It’s no Deal”! You are back to square one and you owe the entire balance. Isn’t that special?!!! Remember that the creditor will write off (charge off) any unpaid debt. The business writes the debt off of their income statement as a loss to subtract against their profits; Lowering their tax bill. Then they sell the unpaid accounts in a package deal to debt broker. When this happens, the creditor will not sue you. Now a debt collector owns your debt and they will collect the debt.
2) Talk to your creditor about creating a “Repayment Plan”. You will lose your credit line. Your credit score will drop. Again, ask the creditor to report nice things about you to the credit bureau. Ask the bank to lower the interest rate, monthly payment and reverse any late fees or penalty fees.
3) Work out a forbearance agreement. What is forbearance? It is a legal term that means you ask your creditor to stop a collection action against you. If your situation is temporary, like a medical situation, creditors may reverse any late payments and penalties. They may suspend payments for a few months. There is no forgiveness of debt.
4) Find a financial counselor or financial coach to create a debt payoff plan. Create a debt payoff Plan. Connect with the FCAA or NFCC. These are legitimate financial educators providing credit, bankruptcy, housing, and Student Loan Counseling for free or at low cost.
5) Consider Chapter 7 bankruptcy getting involved in a Debt Settlement agreement. It’s the most common form of bankruptcy, and it cancels unsecured debts without collateral. Chapter 7 includes credit cards, personal loans, and medical bills. Bankruptcy will stay on your credit report for 10 years. That’s not good. It will prevent you from qualifying for certain jobs. When you borrow again your interest rates will be higher and you will not qualify for the lowest auto insurance rates as statistics show you are a more reckless driver. You may feel the impact of the social stigma of bankruptcy. You will need to pass a needs test. Active military and veterans have more lenient qualification standards.
Debt Collection Company Debt collection companies buy debt from lenders who have given up collecting their unpaid debts. To a lender, a loan is an asset. If that loan is unpaid, the asset is worth 0. Tax laws allow the lender to write-off the bad debt on their taxes to offset income. This tax law motivates lenders to dispose of and write the bad debt off as a loss as soon as possible. Then the lender sells their bad debts to a collection agency for pennies on the dollar. The debt collection agency then contacts the original borrow to collect whatever they can get the borrower to pay. They only have pennies invested in each bad debt, so they only need a few people to agree to pay some part or most of their debt to be profitable. Debt collectors may call you and write a letter to collect the unpaid debt. Debt collectors can sue you to collect bad debts and file default judgements that show up in the public record. Default judgements are court orders to pay the debt. They can report the unpaid debt to the credit bureaus. Collectors in most states can garnish your wages. There are state and federal regulations affecting wage garnishment in your state. You should know your legal rights if threatened with garnishment.
Members of humanity, for thousands of years, have reported that debt is bad for you. Ben Franklin said it well, “It is better to go to bed supper less, than to wake up in debt”. You cannot borrow your way out of poverty, but you can sure borrow your way into it.
In the book proposal it’s “Debt Consolidations Companies” and I suggest “Using Debt Consolidation Companies” or, because this includes a variety of tactics, maybe something more general like “Handling Debt”?
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