Debt Reduction/Modification....is it safe for you?

“Get out from under your credit card debt now!” “Reduce your debt over 60% and sleep better at night.” “Avoid bankruptcy!”

Don’t you believe a word of it!!!!! This is akin to borrowing from a high interest finance company. Well, I guess I might not go so far as completely telling you not to consider a debt reduction company at all since I don’t know your situation, but I am hoping the information I give you will help you determine whether or not this type of company can do more harm to you than good. I am sure there are consumers that feel these types of options have been helpful and those who have felt totally ripped off. In general these types of companies are VERY risky and can have a long term negative effect on your credit and your ability to get future credit regardless of what they claim.

As I investigate these companies from a potential customer point of view I have formed some common observations. See if these things fit within your hopes and dreams to reduce or eliminate your debt without paying it all back.

These companies typically lure you in by letting you know there is a “secret” credit card companies don’t want you to know. Come on. There is no secret. The secret is one you already know. If you are in trouble with your accounts you call them and try to work out a solution directly with them. The secret is, that with the economy today, most creditors in danger of losing money are willing to talk and to help.

Here’s what I have observed in these programs based on personal conversation with their counselors:

TYPE OF DEBT:
Only unsecured debt is eligible. Unsecured debts are those without assets such as a house, car, bank accounts or investments attached to them should you fail to pay them off. Ineligible debts then would be mortgages, car loans, federally backed financial obligations, and secured credit cards. The most common types of debt eligible for this type of program are unsecured credit cards, signature loans or lines of credit as well as debt from repossession or a debt forgiven.

MINIMUM DEBT:
Most debt consolidation companies don’t want to touch you unless you have a MINIMUM of $10,000 in unsecured debt. The reason? Their fees (revenue) are based on your balances. The higher the balances you have to work on, the higher the fees to the debt reduction company. These companies who charge fees to help you are “for-profit” companies.

FEE STRUCTURE:
Administrative Fees: Almost all of these companies will charge you an administrative fee anywhere from 10-15% of the total balance you want to work on. This is an up front fee payable over the first few months of your plan. For example, if you have about $20,000.00 in a combination of credit cards and small loans you would be charged anywhere from $2000.00 to $3000.00 over the first few months of the monthly payments they set for you. Keep in mind they get paid first before any negotiations on your behalf with your creditors. Fees first, debt payment last.

Monthly Service Fees: Every month you will be charged a separate fee for maintaining and servicing your account. The amounts range from $39.95 to $59.95 per month.

Savings Fee: At the end of the settlement, some companies may charge you another 10% of the savings (difference between what you originally owed and what your creditor agrees to take). Take the $20,000 example. The negotiator was able to secure an agreement to pay your creditor $10,000 in full showing a $10,000 savings to you or 50% of your original balance owed. The additional fee on the amount you saved would be another $1000 in cost to you.

PROCEDURE:

Information Gathering: Information on you is gathered by a counselor. At this time the
total debt is determined in your conversation. At times you may be pressed by your counselor about other debt that can be included. The more debt you want to negotiate, the higher the fees to the company who negotiates on your behalf. WARNING: When you first call these companies they may capture the incoming phone numbers so they can call you back and solicit should you decide not to go forward. Keep in mind also that debt leads (you) can be sold for a handsome sum to other companies offering debt programs.

Paperwork: When you contract with one of these companies you will have several forms to
sign. Most companies will set up a trust or an escrow account where your monthly payments will be deposited and held until you have enough to negotiate with. These trust or escrow account will not accrue interest for you. Others will have you set up your own savings account in the bank of your choice but they will want to be able to withdraw their fees through Electronic Funds Transfers from your account. The advantage of this is that at least while accumulating the funds you can draw interest on them. THE DEBT REDUCTION COMPANIES WILL GET THEIR FEES FIRST before any negotiation takes place on your account. FEES FIRST, NEGOTIATIONS LAST.

Approval for the program: Your information will be presented to an Oversight Board, Underwriters or whatever each company wants to call them. They will determine if you have the ability to make the monthly payments with success. It’s not the debt they are worried about; it’s the fees they want to collect from you.

Monthly Payments: Based on their guidelines and the total of all your debt, you may be
extended payments over 12, 24, 36, through 48 months with the median being 20-24 months. The debt reduction company will tell you to stop making any payments on your debts and make The monthly payments they have set up for you. They will tell you that no creditor will negotiate unless you are behind in payments. Some companies will deduct your Monthly Service Fee from these payments and some will directly charge your checking account as an outside expense. The administrative fee of 10-15% will be deducted from your account over the first 12 or so months depending on your terms. The balance of your payments after fees then goes toward your negotiation accumulation. If you have a company that also takes another percent of the amount they save you, that fee is generally deducted from the balance upon negotiation at the end.

Negotiation: At the end of your monthly payment agreement and not until then can this ompany attempt to negotiate on your behalf. BEWARE: During this time you are not paying anything on your debts and your creditors can still charge fees and interest as well as sue and garnish you. If this occurs, you have paid significantly more than what you owed in the first place. There is nothing about a debt reduction company that legally stops any kind of collection
efforts by your creditor.

Cancellation: If, at any time you cannot continue with this plan you are not obligated for
future fees if you notify your counselor in writing. You are also not entitled to a refund of any
fees that have already been collected as well. In addition, some may have cancellation fees that
I’ve seen as high as $299.00.


Let’s look at the possible financial side of this using $15,000 in unsecured debt. If you contract with Company A you are told that you can pay 20 payments of $502.05 over the next 20 months. That would be a total of $10041.00. From this amount you are assessed a 10% administrative fee of $1500.00 which will be paid to Company A over the first 10 months they withdraw from your escrow account. You are also paying a monthly service charge of $39.95. Over 20 months that would be a total of $799.00.

So far if you honor this agreement your debt looks like this:

Unsecured Debt $15000.00
Negotiate 50% $ -7500.00

Total debt owed $7500.00 You pay to creditor

Add ons:
Admin Fee $1500.00
Service Charge $799.00
Savings Fee 10%
of $7500.00 $ 750.00
__________
$3049.00 You pay to Debt reduction Co.
__________
Total Paid by you $10549.00

$10,549.00 is 70% of your total original debt. This is NOT the 50-60% reduction they claim. Now add to this the potential 18-35% interest rate and all the late fees the credit card companies may assess you and you haven’t saved a thing.

You can work up your own outcome with the information you get from the company of your choice but I will offer these observations for you to think about.

1. If you are behind in your payments you, yourself are in a position to call your creditor and see if you can make some modifications such as a reduced monthly interest rate for a time or a temporary change in the minimum monthly payments. With what is happening in the economy today they may jump at the chance. You may also save your credit report from too many 30,60,90 days lates accumulating on your account that could accumulate waiting for a debt reduction company to work on your behalf. You would be better off applying these payments to your debts on a monthly basis in good faith than hiring a debt reduction company. Most creditors will set up a budget plan with you if you prove you can honor it and make a sincere effort to make good on your debts.

2. Keep in mind that when going with a debt reduction company, there is virtually little contact with your creditor during the time you are sending payments for the time the company has set up for you. The company does not negotiate until it has the funds ready. During this time your balances may increase with fees your creditor can impose on you for non-payment even though in good faith you are putting away money to offer a settlement. Of course debt reduction companys do encourage you to pay more and finish faster but it doesn’t matter to them. During this time of no contact your creditors could increase your balances owed, harass and sue you. Then you are out the money you owe due to garnishment AND the fees you paid this company.

3. While debt reduction companies may NOT report that you are working with them to the credit bureaus, your creditors may directly report a write-off of the amount they negotiate and note that you worked with a debt reduction company in doing so. They also will report an increased debt due to interest and various charges. The hits to your credit report are serious and are not avoidable. Don’t believe a debt reduction company that says they can do anything positive with you credit report. It won’t happen and is not at all possible.

4. If you work up a rather large debt forgiveness with your creditors, they have, at their option, the ability to file a Debt Forgiveness Form 1099-C on you with the IRS. Come next year you will need to include that amount in your taxable income for the year. The only exception today is the mortgage program the federal government has exempted for those in mortgage trouble.

5. If you even remotely entertain this service make sure you research the company you are considering. Check for complains with the BBB and with various other consumer websites. The FTC website is loaded with careful cautions on these companies and has litigated against them.

6. If you are at the point where creditors will not work with you, you are ready to throw up your hands and give up, do NOT fall victim further. Look for totally non-profit debt management companies. They are out there. The trustworthy ones are totally non-profit. No fees. No obligations. They are funded by grants to help consumers for free. Look to your creditors and ask for their advice on debt counselors they trust and work with. Some of them will actually be very helpful. Look to your state’s attorney general or your state’s consumer division for advice on reputable companies if you can’t do this on your own.

7. Remember that credit is a major stressor in our lives. Work as hard as you can to correct your past mistakes, make a plan for the future and do your best. Like a diet, it takes hard work and discipline but you can do it.