Hoboken411 Financial Guru – 11/20/2008
[Continuing the Hoboken411 Financial Guru Series…]
Are debt consolidation programs OK?
Dear Financial Guru,
I’m sorting through my options for paying down my debt. I see those commercials that claim I can get rid of my debt for pennies on the dollar. Are they full of crap? If not, what should I look out for before signing up for one of these programs?
411 Financial Guru Says:
The commercials make it sound so easy. Just make small monthly payments and we’ll make all your debt worries go away. Debt reduction agencies (also know as debt settlement agencies) are relatively new– the industry was non existent 5 years ago. And they’ll probably disappear within the next 5-10 years once the government starts paying attention to some of the questionable tactics they use. (Of course, loyal readers of Hoboken411 would know nothing about your government reacting after it’s already too late!
Here’s an example of how they work. Phil owes $50,000 amongst his 5 credit cards. He pays his bills on time, but his minimum payments are $1300 and he won’t be able to keep up since his cards are almost maxed out. Phil contacts one of those patriotic sounding debt relief places and the smooth talking person on the other line assures him that for $600 a month for the next 4 years, they can get rid of his debt. So, Phil gets the contract, skims through it (who has time to read fine print?) and sends off the first $600. Now, the first $600… and at least the next five payments, sometimes more, go straight to the agency. So, if in month 7, Phil is unable to make anymore payments, he just handed over $5000 and got absolutely nothing.
Find out what else can happen after the jump…
(Hoboken411 Financial Guru – Debt Consolidation, continued…)
Meanwhile, his credit gets ruined since every single one of his debts has now fallen 6 months behind and are all headed to collection agencies or law firms. Usually, these agencies can deflect the harassing calls he’d normally get for not paying any of his bills. But if one or more of them decides to sue him for non-payment, they can’t do anything to protect him. As the prorgram continues, the idea is that money accumulates in an escrow account. Eventually, they try to negotiate settlements on Phil’s behalf. For example, they may try to get 40 cents on the dollar for what he owes. If all goes according to plan, at least it sounds like he would have saved some money. Not so fast– by the time enough money is available to do a settlement, think of all the fees and interest that have accumulated on the original balance. Then, the agency charges another fee based on how much they save for him, typically 25%. And then Uncle Sam gets in on the action– Phil will get a 1099 form that will report income on the amount he saves on each settlement in excess of $600.
So, in the unlikely chance that nobody sued him and the agency negotiated good deals for him, by the time you figure in interest, agnecy fees and taxes, he may end up paying $50,000 or more. Now, I can already hear the comments– isn’t it Phil’s fault if he signs up for this scam? Yes, he has to share some of the blame. If he bothered to read the contract (or asked someone to explain it to him if he didn’t understand it) he’d see that much of what I wrote is stated on the contract– although the agreement won’t state that you’re screwing up your credit, that you might get sued or that you’ll get taxed. The only thing spelled out clearly is their obsecene fees.
Companies like this are taking advantage of people in a desparate situation. Their other options may be limited. If Phil setup legitimate payment arrangements either with his creditors or through the help of a reputable credit counseling agency (www.nfcc.org can refer you to a local agency) he’d likely pay somewhere between $1000 and $1200 a month and have reduced interest rates. If he can arrange his budget to do this, that’s the best option. His credit may get dinged in the short term, but it will improve over the course of the 5 years it would take him to become debt free. But what if he can’t afford a legitimate payment plan? Filing bankuptcy might be one option– while this will severely damage his credit, at least it will give him a fresh start. And while he may hire an attorney (for simple cases, $1500 to $2000) that’s far cheaper than hiring a debt reuction agency.
While what they do may not be illegal, it’s certainly unethical. They take advantage of people with limited financial education. Most of the people whom I help that have been victimized by these services are from low income households. These places employ very talented salespeople who can spin things to sound like this is a great deal. Most of these companies have horrible ratings with the Better Business Bureau (search.bbb.org). You know the old saying: if something sounds too good to be true, it usually is.
Please keep those questions coming to email@example.com.