Debt Consolidation

If your debts are relatively small filing bankruptcy may not be your best option. For smaller debts, obtaining a debt consolidation loan, if possible, may be your best option. An unsecured loan from a bank often carries less interest than credit cards, and if you can obtain such a loan that covers all your unsecured debts, you may be able to reduce your monthly payments and get the debt paid off more quickly.

If it’s not possible to obtain an unsecured loan from a bank, it may be possible to get a secured loan if you have equity in your home or vehicle(s). For example, if you have $20,000.00 or more equity in your home and you have credit card or other unsecured debt of $15,000.00, it may make sense to get a secured loan from a bank to pay off the credit cards. Your monthly payments could be lower and the interest you pay on the loan could be tax deductible. Sounds good, right? It would be if you can pay off the loan and not incur any new debt. The problem many people run into with this option is they get new debt that they can’t pay off and they have now lost the equity in their home.

Debt Settlement

Another option offered is “Debt Settlement”. Depending on your circumstances and who is offering to “settle your debt” this can be a very risky endeavor. The idea is that you quit paying your individual creditors and instead make payments to the Debt Settlement Company. The Debt Settlement Company then negotiates with all your creditors and gets them to reduce the amount you owe them. Again, it sounds good, but often it ends up putting the debtor in worse situation than they were in to begin with.

The problems begin when your creditors stop receiving your payments. Debt Settlement companies will often instruct the debtor not to make payments, to not talk to the creditor or answer their calls or letters. Some Debt Settlement companies will tell you that this is to scare the creditor into accepting less than they are owed. It is more likely, however, that the creditor will file suit against the debtor and get a judgment against them. This then leads to garnishment of wages or bank accounts, and can even lead to repossession of cars, homes or other valuables.

The other problem with many debt settlement companies are the fees they charge. As they say, it’s always important to follow the money. The Debt Settlement company’s business plan is for you to pay them and from your payments to them, they take their fee and then pay a portion of what you owe to your creditors. If their fee is reasonable, and if they were paid after they did their work, this might work more often than it does. However, many unscrupulous debt settlement companies will charge ridiculously high fees and take those payments up front. Meanwhile, your creditors are not receiving any payments. What’s worse is if the debt settlement company does not contact the creditor. With no communication (or payments) coming from anyone, the creditor is left to their own devices. Most of the time this means a law suit that the consumer doesn’t know about until the sheriff comes to their door with a writ of execution.

In the worse cases, consumers pay as much or more to the debt settlement company than they would have paid to their creditors and they get nothing in return except for a notice of garnishment. Everything they paid to the debt settlement company went to their fees and nothing to their creditors. The debtor’s credit is ruined because of the lack of payments and they have nothing to show for it.

If a debt settlement is successful, there are still issues to be aware of. If the creditor has agreed to accept less than what was owed, they may send you and the IRS a Form 1099-C. The 1099-C effectively reports the “written off” debt as income, which you then have to report on your tax return. There are other issues involved, and the best advice if you receive one is to talk to a qualified accountant or tax preparer. But if you are thinking of debt settlement you will want to have a clear understanding of the terms of the agreement with the debt settlement company.

Another important question has to do with how this affects your credit. If your debt has been sold to a third party debt buyer, you may be able to request that their negative account information be removed from your credit report. However the original creditor will not be a party to that agreement and will typically continue to report the negative information.

The drop out rate of a debt settlement program is typically high. The legitimate plans require 12 to 60 months of participation. If a payment or payments are missed, the participating creditors may opt out and start their own collection efforts, which typically include filing a law suit against the debtor.

In May 2009, the New York Attorney General issued subpoenas to several debt settlement companies, investigating violations of New York state law. The New York Attorney General’s office listed the following tips to consumers faced with significant credit card debt:

• Be wary of debt settlement companies which falsely promise to obtain substantial lump sum debt reduction settlements. Many advertise “reduce debt now,” and claim as much as 50% to 75% off credit card debt, but rarely obtain advertised reductions.
• Never agree to sign a contract with a debt settlement company that requires payment in advance prior to obtaining the promised debt reduction.
• Enrollment in debt settlement plans may not stop creditors from bringing collection law suits, or prevent enrolled accounts from growing larger by the addition of late fees, interest, and penalties. Also, credit reports will reflect derogatory information, including assessed late charges and non-payment of debt, and consequently credit scores will be adversely affected.
• Creditors are under no legal obligation to accept a settlement offer for less than the outstanding balance owed.
• Only a small number of consumers who enroll in debt settlement plans have the financial means to complete them. Usually, they drop out after having paid service fees to the companies with no settlements.
• Enrollment in a debt settlement plan premised on stopping payments to creditors will likely lead to more frequent and aggressive creditor collection efforts often resulting in judgments, wage garnishments, and freezing of bank accounts.
• Check with the Better Business Bureau to obtain a Reliability Report on a particular debt settlement company and its rating.
• A wise first step to help resolve an outstanding account is to speak directly to the credit card issuer. Alternatively, it may be helpful to speak to an attorney or an accredited credit counselor who can help develop a plan of action that best works for each consumer’s unique situation.

If you have significant credit card or other unsecured debt, filing chapter 7 or chapter 13 bankruptcy may provide significant advantages to your situation, including the following:

• All collection efforts by your creditors must cease as soon as they are informed that you filed for bankruptcy relief. This includes phone calls, dunning letters, law suits and garnishments.
• Upon successful completion of your bankruptcy, meaning you get a discharge, your debt to income ratio will be significantly better than before. If you stay out of debt going forward your credit rating should improve over time.
• After bankruptcy is done and if a former creditor or debt collector tries to collect a debt that was discharged, that is a violation of bankruptcy law. It is likely that you could successfully sue that creditor in bankruptcy court to stop their collection efforts. That is not the case if you try to negotiate lower payments outside of bankruptcy.

If you have questions about debt settlement, bankruptcy, bill collectors or garnishment, give us a call for a FREE consultation.