Mike headed back to school during his unemployment, hoping to pick up trade skills that will either make him more valuable to an employer or help him branch out on his own. Then, the couple’s young child required some medical care, which the couple really couldn’t afford. They paid for it with their credit cards, and a small revolving debt suddenly became a big one.
Now they are struggling to pay off the debt. Mike and Emily have kept current on the bills, but mostly with minimum payments, and Mike lives in fear that he will spend the next decade or more paying off debt, rather than saving for his daughter’s college costs or his and Emily’s retirement.
So Mike and Emily are considering debt relief. They were getting phone calls about debt settlement, promising to cut outstanding payments and ease their paycheck-to-paycheck pressure. Mike knows that bankruptcy may also be an option if he doesn’t find regular employment soon. But his hope is that he can get through the rough patch, reducing the debt all the while, and come out the other end of the downturn with a new skill set, a new job and a fresh financial start.
“I’ve never picked a debt-counseling company before, but I talked to two companies and they had different plans, different amounts I’d have to pay every month,” Mike wrote me. “I know there are some bad stories about credit counseling. I know it’s not the same as picking a financial adviser, but how do I decide who can help me pay off my debts?”
It’s a great question, especially now that new laws aimed at protecting consumers from debt-settlement companies’ steep fees are set to go into effect — but which some service providers are likely to ignore — at the end of this month.
Debt relief takes many forms
While “debt management” and “debt settlement” may seem like the same thing, nothing could be further from the truth. Debt management typically involves a plan that slows or stops the interest clock but results in the consumer paying his debt in full. Debt settlement generally is about convincing creditors to settle for less money than is owed.
Credit counselors say many consumers are not nearly as far down the debt hole as they think, and that some budgeting and careful planning — along with a payment plan — is sufficient to dig out.
Christopher Viale, president of Cambridge Credit Counseling, says that roughly half of the consumers who seek his non-profit firm’s help can handle the debt problem on their own, after an assessment and plan. Between 15% and 20% of the people seeking services need counseling, including an intervention with creditors, with another 20% to 25% so deep in trouble that bankruptcy is obviously the best course of action. For the remaining group, some 5% to 15% of his customers, some form of debt settlement may be a compromise.
A debt counselor — particularly if he’s from a not-for-profit firm — is typically offering free help, a no-charge chance to develop a plan. A good counselor will need an hour or more just to get a full assessment of the problem, including a full look at what’s coming in, what’s going out and the challenges facing the family, so they can develop an action plan.
If they offer debt management, the counselor will be contact the credit-card companies, reducing interest rates, lowering monthly payments, getting fees waived, stopping the interest clock — whatever they can do to stem the bleeding. Then, they will take all of that unsecured debt and wrap it into one payment, taking the consumer’s money each month and distributing it to creditors. There are no late fees, and all accounts are current; the consumer’s credit score takes a hit at first, but tends to recover as the payment plan proceeds.
In the end, the consumer pays what they owe, but over a longer time frame and at reduced interest rates.
Unexpected consequences
By comparison, for-profit debt-settlement companies will reduce debt, but the consumer may not be thrilled with the process.
The for-profit firms, typically, are the ones doing the heavy voice-mail and email campaigns, and their salespeople are paid on commission. Those salespeople don’t always care to know much about the consumer’s situation; they know they can make money by getting the consumer to sign up for their more radical approach, whether it’s necessary or not.
Typically, credit-card companies won’t settle accounts for less than is owed. That only happens when the card company writes off the account, and sells it to debt collectors or attorneys who buy the debt at a discount and who then accept less than the full amount from the consumer.
With that in mind, debt-settlement companies effectively tell lenders to stop contact with the consumer, and work instead through them. The consumer makes a monthly payment, but the settlement firm takes out the sales commission and any upfront fees. The remaining amount sits in an account until the consumer has defaulted, with late fees and other charges mounting all the while.
When the account is four to six months in arrears and the lender must get it off the books, the debt-settlement firm works to get the best deal from whoever takes over the debt, using the war chest of payments made to that point as a carrot. Collectors willing to forego a big chunk of what the consumer owed to get a piece of that pie will cut a deal; others will go to a payment plan, knowing that the consumer is at least putting money on account every month.
Card issuers, not amused by these tactics, are increasingly turning the accounts over to attorneys, who sue the delinquent customers. That’s why the strategy is particularly risky; for many debt-settlement customers, bankruptcy would be cheaper and easier.
The government has been trying to clean up the collections and counseling arena for years now; the latest change will go into effect next month. It basically eliminates the commissions and upfront fees that eat into the debt-settlement payments, holding costs down to a small application fee and processing fee.
That said, debt-settlement firms will still be allowed to charge a “success fee” when they strike a deal with a lender, and those fees have no limit. You could wind up paying much of your savings to the agency.
Further, many people in the business believe the new rule doesn’t apply to debt-reduction attorneys, but only to credit-counseling firms. As a result, some settlement firms appear to be taking on figurehead attorney leaders, so they can do business as usual, no matter what the Federal Trade Commission says.
“People who have debt problems tend to be too focused on the monthly payment, and tend to pick the lowest payment they can get, because it gives them the most breathing room,” said Viale. “It may be cheaper and easier every month, but it may be very costly over time. Take the time to get a plan, to understand how it works and to focus on doing what’s right for you. If someone says they can get you out of debt ‘right now,’ they may hurt you as much as they help you.”
No comments:
Post a Comment