by Jennifer Wallis
When I was in college, I worked at a local garden center. When the weather was nice, we would open the greenhouse doors. Often, some confused bird would wind up trapped inside the greenhouse. No matter how much we tried to guide it toward the doorway, sometimes the bird would fly right into the glass panels. It was trapped and in its state of panic, it flew beak-first into the first place that looked like a way out. In the best case, the bird would end up a little wiser; escaping with just a sore beak. When humans feel trapped, we may behave much the same way; panicking and rushing into the first place that looks like a way out.
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When the trap you’re caught in is debt, it’s important to carefully weigh your options before choosing your escape. Some options can really help you become a better consumer. Sadly, others may make your situation worse by causing harm to your credit and costing you even more money. While some organizations truly have altruistic motives there are many that only want to make money from your misfortune. If you are in debt and are looking for a way out, it’s important to choose a good organization to help you and avoid flying headfirst into more trouble.
Recently at my job in a non-profit credit counseling agency, a young soldier scheduled an appointment. He had considered signing up for a debt settlement program with a company he had found on the Internet. Since he was in the military, it was required that his Commanding Officer (C.O.) sign off on his enrollment into the program. When the C.O. saw the program he was about to enter into, he promptly brought him to our office as an alternative. While debt settlements may be an option for some consumers, the C.O. believed that it would not be in this soldier’s best interest.
According to the soldier’s paperwork from his consultation with the debt settlement company, he owed nearly $33,000.00 in unsecured debt. His debt settlement plan would take 36 months. For the first 3 months all of his payment of $658.00 would go to the company for the fee. For the next 10 months, the client would pay $658.00. Nearly $300.00 of that would be the company’s fee and the remaining money would be placed into a ”savings account” for the client. For the duration of the program, the client’s payment would be placed into the client’s “savings account” with the company. The client would end up with more than $14,000.00 in his savings account, to be paid to his creditors. Total fees for this program would be nearly $5,000.00 for a 3 year program or roughly $140.00 per month.
What does this $5,000.00 buy the client? Well, for this fee the company tells the client not to pay any of his creditors. Some debt settlement companies even require that the client sign a Power of Attorney, which gives them the right to make financial decisions on the client’s behalf. Over time, the creditors begin to believe that this client is not going to pay them anything. The creditors will still send the accounts to collection agencies, call the client, send collection letters, report the client late every month to the credit bureau and may eventually charge off the account as bad debt.
If the creditor opts to sue instead of charging off the debt, the debt settlement company still instructs the client to not respond to the lawsuit. Then, the debt settlement company will contact the creditors and offer to send out of the clients “savings account” 50% of what the client owes. Because the creditor never thought they’d see any of the money the client owes, they may agree to settle for just 50%. The client may indeed end up only having to pay back 50% of their debt, just as the company claims.
What do you think this does to the client’s credit? Imagine a credit report where every account reflects that the client just stopped paying their debts. There will be reports of accounts that are 30, then 60, then 90, then 120 days late. During this process the creditor will still charge interest and late fees so the balances will go up considerably.
Once the account gets to 150 days with no payment the creditor will charge off the account (if they did not file a lawsuit) and rate it as a 9, which is the same rating as bankruptcy. The credit report will be littered with collection, charged off accounts, and possibly judgments. In Oklahoma , a creditor who wins a judgment can also garnish wages so settling may not be an option.
If the debt settlement company eventually does negotiate a settlement on the client’s behalf (something a client in this situation could probably do for himself) the credit report will change the balance to zero and will usually report the debt as “settled for less than full amount.” All of this activity stays on for 7 years so any lender looking at the credit report will see all of this information.
What is the real cost? In this soldier’s situation, the company told him that it will save him $13,000.00 since they will attempt to settle his debt for 50% of what he owes. While he may save $13,000.00 by not having to pay back all of the debt he owes, his credit pays a far greater price.
Studies have shown that clients with a “bad” credit score will pay $250,000.00 more in interest over their lifetime than someone with a “good” credit score. If the client’s credit is ruined, he will have to pay higher interest rates for years to come whenever he applies for credit.
For example, if he were applying for a car loan, a client with a negative credit report may have to pay 21% interest while a person with a good report may be able to finance one for 5%. The result is that the client with the bad credit report will have to pay nearly 3 times the amount of interest.
If you find yourself in a financial situation that you need professional help getting out of, it’s important to ask a LOT of questions.
Here are a few questions that can help you get the right information:
What is the total amount of the fee I will pay?
Many non-profit agencies can help you for free or very low cost. If the fees seem unreasonable, keep shopping. Many companies will divert your attention away from the fees and try to get you to focus to how much you will save by settling your debt. Don’t fall for it.
How will this affect my credit?
Watch out for smooth talk. If their only answer is that it will help you avoid bankruptcy that is not answering your question. Find out how things will be reported and if the program will damage your credit. Most reputable debt repayment plans have minimal impact on your credit report. If the plan will cause great harm to your credit, ask yourself if you will need to borrow any money in the next 7 years. If so, look for another plan.
Do I have to sign over Power of Attorney to your company?
If so, I’d be very wary of that situation. Power of Attorney allows someone else to sign your name and make financial decisions on your behalf. It is usually used when an elderly person in failing health allows a family member to make financial decisions on their behalf. It is also used by military personnel to allow a spouse to make decisions while they are deployed. If anyone other than someone you trust very closely asks you to sign over Power of Attorney, I’d look for another option.
What are my other options?
I would stay away from any company that discourages you from shopping around for other alternatives. Any company that truly has the best option will welcome the chance to show you why their product is superior to others. If you feel pressured, walk away from the deal.
I understand the stress that financial problems can cause. I also know that human nature tells us to fix a problem as quickly and (seemingly) as painlessly as possible. However, when you are in trouble, it’s important to look at every option you have. Budgeting, asset liquidation, credit counseling, home equity loans, second jobs, and yes, even bankruptcy are all viable alternatives to debt settlement.
If you do decide that debt settlement is the best option for you, shop around, know the fees and understand exactly what will happen to your credit. You may find that choosing the wrong way out of debt can be more painful than staying trapped.
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Copyright © 2006 by Jennifer Wallis. All rights reserved.