YOU HAVE A RIGHT TO SETTLE YOUR DEBT!! REALLY??
by Tom Coates
Most have seen and heard these commercials. Even more irritating is that a large number of today’s “robo” calls are generated by these people. Who is this new player on the field? Debt Settlement. It has taken off like a rocket!!
The initial promise to consumers with credit card debt is that it will be easily settled at a fraction of the amount owed to the creditor. The reality is quite different and not for the faint of heart. Debt settlement is essentially a high stakes game of chicken. The program requires the stoppage of all payments to creditors. The company begins escrowing the payments and no contact orders are sent out. Delinquency and then charge-offs, of course, are a result. Many consumers are not advised of the disaster that quickly befalls their credit scores. The settlement companies then move to offer between 10-50 % of the original debt. The interest and late fees by the creditors continue accruing during this process. The most recent statistics show that only 43% of the original number of creditors are paid. The clients that do see it all the way through still pay 78% of the original debt. The difference is the large fees charged to the clients.
I have a recent print out from one outraged client, who after one year realized that 72% of their money evaporated to fees. This client, like many in debt settlement, dropped out after lawsuit filings began showing up. Credit scores in the toilet, judgments and garnishments moving forward, and money swallowed up by fees. This is too often the ending result for debt settlement clients. If the creditors do agree to the offers and the forgiven amount exceeds $600, state and federal taxes may be assessed. As a result, many clients will be driven to bankruptcy court.
These growing abuses have not gone totally unnoticed by some regulators. The rise in complaints have resulted in a growing number of state actions. The CFPB finally entered the arena on 11/8/17 and filed suit against the largest provider, Freedom Debt Relief.
I recently spoke with a local attorney who filed suit in August 2018 for grievous actions by another debt settlement company. The case is going to jury trial in Dallas County and is pending.
Of course, none of this paints a pretty picture. The other issue I want to explore is the confusion by the public as well as many professionals as to the difference between debt settlement and credit counseling. The credit counseling agencies got their start in the 1960’s. Virtually all today are 501C3 non-profit agencies.
Credit counseling agencies receive grant monies from primarily the large credit card issuing banks. The banks have long recognized the value provided to their customers and themselves. Thirty years ago, a study done by the banks showed that even with maximum concessions granted, their return was 17% better than not getting credit counseling involved.
The clients are offered free initial counseling which usually lasts close to an hour. The clients’ budgets are closely scrutinized by a financial counselor. Options are presented that best suit their particular circumstances. In 30-35% of the time a debt management program is initiated. This is where we contract and set up regular payments into our trust account. These payments are distributed monthly to the creditors. The major banks have preset concessions for the participants. These normally include re-aging of delinquencies, reductions of minimum payments and reduction of finance charges.
I will give two examples that occurred this month in our office.
Client # 1 had $44,000 in credit card debts. Scheduled payment was $1,210 and interest averaged 25% on the three credit cards. It would require 9 years to pay the debt in full. After the DMP program went into effect, payment including agency fee, declined to $1,040. Average interest rate is reduced to 4 ½ %. Net savings to payoff is $54,000 and the term reduced to 4 years.
Client #2 had $39,000 in debt with even higher original interest rates. Our DMP was able to give them interest reductions to 3 ½ %, with net savings of $92,000 and similarly reduced term.
One issue often overlooked is the positive impact on credit scores over time on a DMP. Our own in-house study showed an increase in the average FICO score of 34 points over the first 18 months on the plan. Other studies have shown similar results. This stands in sharp contrast to that of debt settlement. A dramatic drop in the FICO score results from months of delinquencies and charge-offs.
Since we offer free counseling and nominal monthly charges, people ask how we are able to stay in business. I have used the old joke that we lose money on every client, but make it up in volume. The real answer is that the ongoing grant and fair share contributions from the creditors have subsidized the clients. Our own agency, Consumer Credit of Des Moines, was established in 1987. It has served as Iowa’s largest credit counseling agency for most of these last 32 years. We estimate over 150,000 individuals and families have been assisted in the repayment of their debts. The most important feature of what we do is the learning experience of our clients in regards to the handling of their money.
In conclusion, I hope this has shed light on the realities and differences in these two very diverse industries. If you have further questions, please contact me.
Tom Coates – Director
Consumer Credit of Des Moines
6129 S.W. 63rd Street
Des Moines, IA 50321
515-287-6428 ext. 117