Charles Phelan

Three of my previous posts were on “Crazy Stuff Collectors Say.” In case you missed those posts, here are the quick-links to the previous articles:

Crazy Stuff Collectors Say – Part I
Crazy Stuff Collectors Say – Part II
Crazy Stuff Collectors Say – Part III

I wanted to follow up on this theme, because lately I’ve been hearing a lot of reports from clients on a tactic that seems to be getting more and more play. It’s been around forever, but I’ve been hearing it used much more often recently. Here’s how it goes:

You get a voicemail message (because you’re screening your phone calls) from a collection agency or a collection attorney firm. “This is Joe Smith with XYZ Company. I have your case file on my desk – number 12345. I strongly recommend that you have your attorney call me immediately.”

Scary sounding, right? Nope! Just a debt collector trying to get you to call back for another dose of verbal abuse and strong-arm collection pressure.

Third-party debt collectors are not permitted to threaten litigation unless (a) they are in a position to bring said litigation, and (b) they have been authorized by the creditor to file a lawsuit. But the above voicemail message technically does not violate that rule. Notice the technique. They did not say they were going to file a lawsuit. Instead, they referred to a “case number,” and you automatically think “court case” when they meant their internal file reference number. Next, they are telling you to have your attorney call them. You immediately think, “Oh, no! I must be getting sued!”

Folks, this is a BLUFF, and that’s all.

The collectors using this technique are usually the LEAST likely to bring an actual lawsuit. It’s a tactic used frequently by agencies located in a different state than yours. It’s getting harder and harder for these collectors to reach debtors, as more people become aware of their rights under the law. So this is a common tactic employed to create what I call a “false sense of urgency.”

If you are on the receiving end of collection activity and you get this type of voicemail or message, remember it’s most likely just a collection tactic to get you to call them back. If you think you might have been sued, but you’re not sure, then simply call your local courthouse and ask. It’s that simple.

People keep trying to reinvent the wheel when it comes to debt negotiation and settlement. It’s not rocket science, and there are really only a few simple principles that need to be followed to avoid problems. It’s the fancy footwork and dodgy tactics that cause all the trouble.

Here’s a good example. Recently, I’ve been asked by several people about a recommendation they came across on the Internet regarding debt settlement letters. I have not yet been able to locate the source of this spectacularly bad “advice,” so I don’t know the exact language of the recommendation. But the basic idea is that a special clause be added to the settlement letter with the aim of avoiding income taxes on the cancelled debt.

A little background first. When a creditor forgives or cancels a debt, and the portion forgiven is $600 or greater, the creditor is required to report that to the IRS on Form 1099-C, Cancellation of Debt. This amount must be claimed as ordinary income by the debtor on their income tax return for that year.

Someone apparently thinks they have invented a way of dodging the tax issue by getting the creditor to add a clause to the settlement letter that the unpaid balance is “in dispute,” or words to that effect — the theory being that no tax liability can result from a debt that is in dispute rather than formally cancelled or forgiven. In other words, if the written-off portion is classified as being “in dispute” rather than cancelled, then the creditor does not need to issue a 1099-C, and if you get audited you produce the letter to prove to the IRS that no agreement was reached.

This is a DANGEROUS technique that should NOT be used.

The purpose of a settlement letter is to document PERMANENT RESOLUTION of the debt. It’s a document that proves once and for all that you are done with that debt forever. And proper documentation is ESSENTIAL to the settlement process. The main reason is because of the massive $100 billion debt purchasing industry that scoops up millions of old debts for pennies on the dollar, with the aim of making a hefty profit on what they collect. Mistakes happen all the time.

People who settle only based on a verbal agreement may find that their supposedly settled debt was sold to a debt purchaser, who simply refuses to believe the account has been settled. “Prove it!” they will say. Without a settlement letter, you don’t have a leg to stand on. It’s your word against theirs, and don’t expect any cooperation from the original creditor. They already lost money on you and won’t want to spend any more labor-hours trying to help you fix your own problem two years later.

If you have a rock-solid settlement letter, then none of this is a problem, and you can instantly put to bed any issues that might crop up along these lines. However, if you have DISPUTE language in the settlement letter, then you do NOT have a settlement letter at all! You are left wide-open to collection activity and possible litigation in the future. You will not be able to prove this settlement was a formal settlement acknowledged by both you and the creditor.

This is a good example of someone trying to be too clever for their own good. No one wants to pay more taxes than necessary. But by trying to make a settlement letter do double duty like this, you run the risk of collection activity on the unpaid balance. Further, there is usually no reason to have such language added in the first place. The IRS allows debtors to exclude 1099-C amounts from income to the extent by which they are insolvent at the time of settlement.

A majority of people who pursue debt settlement are insolvent (i.e., they have a negative net worth), and therefore do not need to pay taxes on the forgiven balances anyway! What a shame to blow a nice settlement over something that was never even an issue in the first place.

This article will describe the success story experienced by one of my clients, who used my training and coaching program to settle their own debts. The client handled all the negotiations himself, and therefore did not pay any fees to a settlement company. It’s a great example of the power of debt settlement to rapidly turn around a desperate financial situation. The facts and figures are all real, as documented by the client himself. However, to protect his privacy, I’ve changed his name to Bill and his wife’s name to Susan. I’m also going to exclude the names of the banks involved.

I have two reasons for doing this. First, the percentages that various banks will settle for changes frequently. Settlement is a moving target, and I don’t want people to assume they’ll get the exact same deal with these banks. Second, the power in this example lies in the end result, as represented by the average settlement percentage of 40% net, and this is a reasonable approximation of what most debt settlement clients can expect anyway.

One of my purposes in posting this rather lengthy article is to document the power of debt settlement as it stacks up against a Chapter 13 bankruptcy scenario. The differences will become quite clear as the example unfolds below. I’ll start with a quote from real-life client “Bill” — who sent me the following email in July 2007:

“We did it!!! We settled the last account yesterday. Please see the attached excel spread sheet with the overall net percentages (less than 40%) … Thanks again for your help through this. It is hard to believe we accomplished this in what I consider a relatively short time period. We invested in your coaching program in June of 06, and settled our 6 cards (approximately $100K of debt) in a one year period. We also managed to salvage our credit during this time with no judgments or bankruptcy. We are so happy to have this past us so we can move on to a debt free life.”

Since the spreadsheet Bill sent me was very detailed, it laid the groundwork for a very detailed analysis of his case history. Let’s start with the situation as it existed back in June of 2006 before he got started. There were 6 credit card accounts, with balances and interest rates as follows:

Card A $17,937 25.49%
Card B $17,786 18.49%
Card C $14,415 7.99%
Card D $13,997 14.20%
Card E $13,089 18.49%
Card F $ 5,802 0.00%

Total starting debt = $83,026

Bill and his wife Susan were struggling to keep up with total monthly minimum payments of $2,025, and seeing virtually no progress in reducing the total balances. In Bill’s own words, here is what led them to this situation:

“My wife and I were suffering from the classic case of a start-up business going bad. We tried to make things work, but were not successful in doing so. This lesson learned left us with a huge debt problem. We so desperately wanted to make things work. We went weeks without pay. We ate through all of our savings. We then turned to our credit cards to survive. After all we had outstanding credit. It would be just what we needed to get back on track until we could get things going again. Then it did not get any better. We were still not taking in the pay we needed to survive, let alone making payments on the huge debt we had compiled on our credit cards. I started to do research on filing bankruptcy. In doing so I also decided to look for other alternatives. This is when I discovered your site. I ordered your CD kit, and listened to the entire course. It all made total sense. We followed your model, and one year later we had settled on all six of our cards. The 6 accounts totaled more than $83,000 in debt to start.”

Let’s consider what Bill and Susan would have faced had they tried to pay off this amount of debt via minimum payments. Depending on what happened in the future to the interest rates, they would have had to shell out at least $250,000 over the next 10 years, and if there was ANY trouble at all along the way, with even a SINGLE missed payment, that figure would have jumped to $350,000 to $400,000 over a much longer period, possibly as long as 20 years. We’re talking about $2,000 per month for a 10-20 year period of time. That same future flow of payments invested into a good mutual fund could grow to more than a $500,000 nest egg for retirement! So the “opportunity cost” of carrying more than $80,000 of debt was enormous — basically it represented the difference a comfortable retirement down the road versus retirement on a limited fixed income tied to Social Security.

Due to the change in the bankruptcy rules in 2005, Bill and Susan would have had to file under Chapter 13, which involves a payment schedule for 60 months (5 years). We don’t know the precise payment level that would have resulted, since they never went ahead with a formal bankruptcy, but based on a rough estimate of their income and expenses, the Chapter 13 payment would have been a minimum of $1,000 per month, and possibly as much as $1,500. So had they pursued Chapter 13 as their solution of choice, they would have paid out somewhere between $60,000 and $90,000 over the next five years. Bear in mind that Chapter 13 also includes a lot of restrictions, such as the potential for future pay raises to be absorbed by an increase in the payment to the court trustee. Ditto for tax refunds as well as any new sources of income. At the end of the 5-year struggle to maintain the Chapter 13 plan, they would basically have paid back most or all of the starting debt figures. What would they have to show for their effort? A bankruptcy on the public records section of their credit report!

So Bill and Susan decided to give debt settlement a try instead of putting themselves through the ordeal of a Chapter 13 bankruptcy. Let’s have a look at the results.

Card A started at a balance of $17,937. It inflated to $20,855 by the time they settled it for $6,300. (See my blog post of May 15th for a detailed explanation of this “inflation” factor and why it’s a normal part of the process.)

Card B started at a balance of $17,786. It inflated to $20,548 by the time they settled it for $6,153.

Card C started at a balance of $14,415. It inflated to $17,459 by the time they settled it for $6,111.

Card D started at a balance of $13,997. It inflated to $17,165 by the time they settled it for $14,000.

Card E started at a balance of $13,089. It inflated to $16,008 by the time they settled it for $4,500.

Card F started at a balance of $ 5,802. It inflated to $7,316 by the time they settled it for $2,600.

The overall combined figures are as follows. The starting total of $83,026 in debt inflated to $99,352 by the time everything was settled. Again, my blog post on “debt settlement arithmetic” goes into more detail, but the main point to understand is that during the 12-month period it took them to settle, Bill and his wife took control of the cash flow and banked the $24,000 in payments they would otherwise flushed away on interest.

Adding up the final settlement tally, they paid out a total of $39,664 against $99,352 of debt (based on the balances at time of settlement), which represents an average settlement result of 39.92%. Naturally, Bill and Susan were elated with a savings of around $60,000!

Now, if you paid close attention to the above figures, one account probably jumped out at you. Look at Card D, which ended up with a very high settlement percentage (more than 80%) compared to the other accounts. This leads to a point that I make over and over again when discussing the debt settlement strategy with debt-strapped consumers. Bill had to settle this one account at a high percentage because the creditor had started to initiate a lawsuit. Since he didn’t want to see a judgment, which could have led to wage garnishment or a property lien, Bill chose to put the fire out by accepting a high-percentage settlement.

My point here is that Bill’s debt settlement program was a tremendous success, EVEN THOUGH ONE CREDITOR FILED A LAWSUIT! Even with that one ugly situation included, they still averaged 40% overall, wiped out about $100k in debt for $40k, and finished out the whole process in about 12 months. Compare that to the $60-90k they would have paid out during a 5-year bankruptcy, and you can see that one problematic account did not impede their progress at all.

A logical question to ask is, where did the money come from to do the settlements? Remember, $24,000 of the $40,000 needed to settle came from diverting the existing minimum payment money into a savings account. The remaining $16,000 came from a combination of selling unneeded household items, along with a private loan from a family member. So Bill and Susan were able to wrap up everything in one year. Now they can begin the process of restoring their credit score a full 4 years earlier than they would have been able to under the Chapter 13 scenario.

I hope the above information helps consumers to better understand the power of this option. Debt settlement is not suited for every financial situation. But when it fits the circumstances, debt settlement is a POWERFUL strategy for turning financial desperation into debt-freedom!

It’s time for me to bust another common debt-related myth that I get asked about frequently. Basically, the myth is that once a creditor records a “charge-off” when your account is declared a bad debt and a loss is recorded by the creditor, then the creditor no longer has a right to attempt further collection on that written-off debt.

Here’s a quote from a bogus “debt elimination” website that pretends to be a valid source for consumer education in financial matters: “They cannot collect one penny,” the website says. “If you see charge-off on the account they are trying to collect on your credit report it is illegal for these debt collectors to collect one penny. The original creditor took the bad debt as a loss when they filed their income tax and got a credit benefit from the IRS.”

What a load of horse manure! Folks, this statement is Completely 100% FALSE. Aside from the fact there are millions of debt collection lawsuits/judgments that prove otherwise, this ridiculous pronouncement does not even make sense from an accounting perspective.

When a creditor records a charge-off, they are forced to “write off” the uncollected balance, usually after 180 days of delinquency. Naturally, this translates to less income, which lowers the corporate tax owed for that year. Even on this point, the website gets it wrong, because this is not a “credit benefit from the IRS,” but rather a lower tax bill because the company made less money to be taxed on.

OK, so far so good. But let’s say the creditor is successful through the collection process and recovers 50% of the balance that was written off. What happens next? Simple. The recovered amount is recorded as an ADJUSTMENT on a separate part of their bookkeeping ledger, usually in a section called “Allowance for Loan Losses.”

Here is a direct quote from the official corporate Form 10-K filed with the Securities and Exchange Commission by one of the world’s largest credit card banks:

“Allowance for loan losses represents management’s estimate of probable losses inherent in the portfolio. Attribution of the allowance is made for analytical purposes only, and the entire allowance is available to absorb probable credit losses inherent in the overall portfolio. Additions to the allowance are made through the provision for credit losses. Credit losses are deducted from the allowance, and subsequent recoveries are added.”

There you have it, straight from the horse’s mouth. The allowance account is the amount reserved for estimated losses against loans made. When the company record a charge-off loss, it must be deducted from that allowance account. The important bit is that “subsequent recoveries are added” to the allowance account. In other words, in plain English, “it all comes out in the wash.” The recovered funds are simply accounted for separately. And that *new* income is properly taken into account, offsetting a portion of the loss previously declared.

So what does all this mean to you if you have a charge-off account? It’s very important you understand that a charge-off does NOT relieve you of your legal obligation to repay the debt. You are still on the hook to pay that debt (or settle it). This fact is well-known to anyone who has spent more than a few days working in the debt/credit industry on EITHER side of the fence. Only an absolutely CLUELESS amateur – or a deceitful con-artist peddling a bogus “debt elimination” program – would claim otherwise. Yet if you go to your favorite search engine and type in “debt elimination,” you will quickly find dozens of websites that make this absurd claim.

Don’t buy into this nonsense and ignore charge-off accounts just because you read on some website that you’re no longer responsible. It’s vitally important that you (a) understand the status of your debt accounts, and (b) work toward achieving a resolution on those accounts. Otherwise, you might just face a lawsuit that turns into a judgment, which could lead to a wage garnishment or a lien on your property.

Regular readers of The ZipDebt Blog know I frequently write about debt and credit scams, and today I’m posting this entry to warn consumers about a new scam that I hadn’t seen before. Perhaps it’s been around awhile, but this is the first time I’ve noticed it, so I wanted to get this warning out right away.

Here’s the pitch. “We erase your credit card debt by removing late fees, balance transfer fees, overlimit fees, annual fees, and interest charges. We remove fees no one else can.” There is a form to fill out, and consumers are asked to provide the following information:

Name, address, email address, credit card number, 3-digit security code, and Social Security Number and/or account password.

The contact information provided on the website is apparently bogus, with a state that doesn’t match the city and a phone number that doesn’t match the state, etc.

Of course, no one can call a credit card bank on your behalf and just magically get such fees removed! At a minimum, the bank would require a formal power-of-attorney before they would even speak with a third party regarding your account details. Otherwise, they would be in violation of privacy laws that carry steep penalties, and no bank would risk this.

So this is clearly an identify theft scam. The scammers are probably hoping they can fool a few desperate consumers into parting with their personal ID information, including credit card numbers, security codes, and SSNs.

I won’t provide the URL to this scam site because I don’t want them to obtain increased search engine ranking through a linkback. This particular site will also probably be shut down in a matter of days, I hope. But it will probably be replaced by another one at a different address within hours. Most scammers keep rotating website URLs and most likely are operating from a location overseas anyway.

Let’s hope there’s been enough media attention on the subject of ID theft in recent months that no one falls for this ridiculous come-on.

I’m writing this post to cover a subject that comes up frequently when people are exploring the debt settlement strategy. I’m referring to the arithmetic of debt settlement. Many consumers get hung up on the math involved, and this topic usually comes up as a concern or an objection to using the settlement strategy. It often gets expressed as a question: “What happens to all that extra interest and the late fees the bank will keep charging me? Will they waive that when I settle with them?”

The short answer is: “No, they won’t. But you shouldn’t care anyway!”

In order to understand why, it’s necessary to dig into the mathematics of credit card debt. Let’s say you have $50,000 of credit card debt, and you have reasonably low rates on all the accounts because you haven’t hit the wall yet and starting missing payments (although you’re about to fall behind or you probably wouldn’t be reading this). A normal level of minimum payments on $50,000 of credit card debt would be around $1,250 per month. That translates to around $15,000 in minimum payments on an annual basis.

At that minimum-payment pace, it will take 10 years or more to pay off the debt, depending on your interest rates. Let’s assume it would take “only” 10 years to pay off the debt this way. That means the total payout would be $150,000 ($15,000 per year for 10 years). Bear in mind that a 10-year payoff scenario via minimum payments is very unrealistic. The reason is because one missed payment during that entire time is enough to trigger sky-high interest rates across the board, resulting in a much longer payoff period, like 20-30 years or more.

The key point to understand in the above figures is this: Basically, you’re paying $15,000 per year for the privilege of STAYING IN DEBT, to the tune of $50,000. Now, if you get off the payment train, you can certainly expect the train to continue rolling down the tracks without you! So, if you temporarily suspend payments, the total debt level will inflate quickly, simply because you’re not sending in enough to cover the finance charges that will continue to accrue.

Let’s say your average interest rate climbs to 28% and you also start getting hit with $39 late fees. Let’s also assume the $50,000 is spread across 6 different credit card accounts. Over the initial period of 6 months, the $50,000 of debt will inflate by around $8,400 based on these figures, and now you’ll owe $58,400, not $50,000. Around $7,000 of that inflation is due to interest ($50,000 at 28% APR for six months) and the rest is late fees ($39 per month on 6 accounts for 6 months).

But hold on a minute! You haven’t been making payments, right? Remember the $1,250 per month you were shelling out, just to stay in debt for the next 10 years (or worse)? Well, save up 6 months’ worth of that minimum payment moolah and now you have $7,500 sitting in the bank. So the TRUE inflation is around $900, and NOT $8,400, because you have to factor in the $7,500 that you have set aside.

OK, so how much debt can you get rid of for $7,500? If you settle one or two of your accounts at 50%, that $7,500 will clear out $15,000 of debt, leaving you $43,400 in debt, not $58,400. And if you do better, with an average settlement of 40% (which is very realistic in many cases), then your $7,500 will retire $18,750 of debt, leaving you with $39,650 of debt remaining to settle. So over the course of six months, you’ve already made a HUGE dent in a total debt load that would have otherwise taken at least 10 years to pay off, if not much longer.

Now, at the end of that initial 6-month period, the accounts you were unable to settle (for lack of funds) will go through the standard charge-off process and get assigned to collection agencies. Normally, the late fees and interest will stop at that point, although in some cases the inflation will continue. It’s mostly the debt purchasers that try to inflate the debt by back-dating interest to the point of charge-off. But the worst of the inflation of debt stops after charge-off, which allows consumers to continue repeating the above process until they have successfully eliminated all their debt in a 1-3 year time-frame. The program duration is dictated by the pace at which you can accumulate funds toward settlements.

Any way you slice it, settlement makes sense mathematically. Once you realize that your $50,000 debt problem is NOT a $50,000 problem, but really a $150,000, $200,000, or $250,000 problem (when paid back via minimums only), then you’ll see that the inflation factor (while you’re waiting to settle) is no big deal. Even if you end up paying out $50,000 over a 3-year program, isn’t that a whole lot better than paying out $150-250k over the next 10-20 years?

The true tragedy of credit card debt is that most people have sufficient cash flow to settle out their accounts. In our example, you were paying $15,000 a year in minimum payments, but not getting anywhere. Three years of that equals $45,000, and is plenty to retire the full debt load even after it inflates significantly due to interest and fees. It’s just that the banks have people caught in the spring-loaded steel trap of relentless credit card mathematics. But it’s only a trap when you play the game the way the banks want you to, that is, to be hostage to minimum payments for the rest of your life. Once you take charge of the situation, suddenly the math starts to turn around and work in your favor again.