Charles Phelan

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.

In my previous post, I debunked one of the pitches used by settlement company sales reps, namely that such companies supposedly bundle numerous accounts together so they can get a lower overall settlement percentage. In this post, I’ll tackle another commonly heard sales tactic. This one usually comes from “debt elimination” firms which I consider to be nothing more than scams, as well as debt settlement company reps. Here’s the basic pitch:

“The credit card banks don’t actually lose any money when you stop paying them. The reason is because they recover 60% of the money through insurance claims, another 30% through tax credits, and the remaining 10% by selling the account to a debt purchaser.”

Sure, right. If you believe this claim, then you might be interested in a nice bridge that I’d be willing to sell you for a very reasonable price!

Before I expose the reality behind this nonsense, let’s ask the obvious question. Why would a debt company allow its reps to make this claim to a prospective client? I can certainly understand why the scam operators would allow it, because 99% of what they say is bogus anyway, and also because they are actively trying to convince people that it’s OK to walk away from their obligations.

But there are also debt settlement companies that peddle this particular brand of horse manure to the public. Why? Simple. It’s an easy way to overcome sales resistance. There is a key fact about debt settlement that must be understood. No bank will settle with you if you are making regular monthly payments, period. Yet most people are reluctant to stop paying their minimum monthly payments.

Now, it’s one thing to adopt this aggressive debt reduction approach if you simply can’t keep up your minimum payments, and your only other option is bankruptcy (especially Chapter 13 bankruptcy). It’s another thing entirely to use this method when you have better options. But the larger debt settlement companies are volume driven, and their success often depends on getting people who are “on the fence” to go ahead and enroll.

The average person is honest and used to paying their bills on time every month, even when it’s a struggle. It’s a big decision to get off the payment train and let the train roll down the tracks without you. Sometimes a little push is required, and that’s where this sale pitch can come in handy. When a person resists the idea that they should stop paying their minimums, the rep assures the client that it’s really no problem at all.

Let’s not kid ourselves, people. When you don’t pay a credit card debt and the bank is forced to write off the account (at charge-off), they take a loss. There are no ifs, ands, or buts about it. A loss is a loss, period, and wishful thinking will not make it otherwise. Debt settlement involves a compromise where the creditor gets back *something* – less than the client owes on the debt – but probably more than they would receive if the client chose to file bankruptcy. So debt settlement represents an opportunity for the bank to “lose less.” But there is still a true loss involved.

What about the sales pitch described above? Is there any truth at all to it? Nope. Let’s take this claim apart one piece at a time. For starters, the average selling price of a debt account is less than 4 cents on the dollar, not 10 cents. A debt purchaser that consistently paid 10 cents on the dollar would quickly go out of business, simply because they never collect anything on most of the accounts purchased. Second, there is no “tax credit” when a creditor writes off a bad debt. Only someone who flunked accounting would make such a claim. Sure, if a bank loses $10,000 in writing off your account, they may pay $3,000 less in taxes (assuming a 30% corporate tax bracket). But this is not a tax *credit* at all. Rather, the loss reduces the tax owed, but that’s because it was a LOSS!

Finally, what about this notion of “insurance”? Folks, there is no such thing as an insurance policy that protects a credit card bank from customers who default on their obligations. The reason is simple enough, really. The COST in premium payments for the policy would be greater than the amount of losses involved, by definition. Otherwise, the insurance company could not make any money on the product, and insurance companies do not operate for charitable purposes! Unlike life insurance, where a company can spread the statistical risk of a single person dying early (before life expectancy) against a pool of thousands of people, there is no way to spread the risk of credit card defaults. Where would the insurance company spread the risk to? This myth probably originated when someone confused insurance with the concept of a “reserve” account. Creditors do create reserve accounts against losses in order to smooth out their cash flow, but this is not the same thing at all as insurance, any more than a smaller tax bill (caused by a loss) represents a tax credit.

Here’s an analogy that will help you understand the difference. Let’s say that based on your experience from prior years, you anticipate $1,200 per year in car repair expenses, but you still have no idea as to which months the repairs will become necessary. To avoid leaving yourself short, you set up an account and deposit $100 per month into that account, so the money will be there when you need it. This is a type of reserve account, where the money is held for a specific purpose. Nothing about this is “insurance,” because it’s all YOUR money at stake. It’s no different with the reserve accounts that banks set up to better manage their cash flow. It’s ALL their money, period.

Also, the above is a gross oversimplification of what really goes on in the credit card industry. The true technicalities are very complex, involving securitization of credit card receivable portfolios, establishment of credit card trusts, and sophisticated financial arbitrage procedures. But none of this has anything to do with “insurance.”

In conclusion, any debt settlement company sales reps that tout this nonsense should be deeply ashamed of themselves. The debt settlement industry already has an image problem, and it faces an uphill battle for legitimacy in the eyes of the public as well as regulatory officials. The industry’s cause is certainly not helped when executives permit their sales reps to make false or misleading statements to prospective clients just to close the sale.

Consumers often get in touch with me after they have already talked to one or more debt settlement companies. They are attracted by the idea of using the do-it-yourself approach to debt settlement, especially when they see how much they’ll save on the fees charged by settlement companies. However, there’s one common claim made by the reps who sell debt settlement services that sometimes discourages people from using the DIY approach.

The sales claim in question is usually stated as follows:

“We have thousands of clients, and we bundle our debts and settle dozens (or hundreds) of accounts at the same time. So we can get a much better deal for you because we’re doing these settlements in large blocks. You’ll never be able to get as low a percentage on your own as you will through our service.”

With apologies to some of my friends in the settlement industry, it’s time to explode this little myth. The claim, as stated above, is marketing hype and that’s about all. Facts are facts. And the simple fact is that debt settlement companies have NO relationship with the major credit card banks. I don’t know of a single settlement company, even among the very largest firms, that “bundles” debts when they settle with the major banks. In fact, very few settlement companies actually settle with the credit card banks anyway.

The reason is because clients are mostly paying fees during the first year, and rarely have anything saved up to settle with. And since the banks write off the accounts at 180 days of delinquency, hardly any accounts get settled directly with the banks these days. The majority of these accounts are getting settled AFTER charge-off (an industry term meaning a written-off debt) through third-party collection agencies, collection attorneys, and debt purchasers.

Bear in mind, this is NOT the case at all when you do it yourself. When you’re not paying sky-high fees, usually 15% or more of the total debt, then you can build up enough savings in the first six months to handle at least some of the accounts directly with the original creditor.

Taking this a step further, use of a settlement company can actually result in a far worse settlement than the consumer can get on their own. One major credit card bank will immediately forward your account to a local collection attorney with authorization for a lawsuit if they receive ANY notice from a debt settlement company. Once that happens, you’re lucky to get an 80% settlement!

Just this morning, one of my clients reported a settlement directly with this same bank at 35%. So the sales claim is certainly false when this creditor is involved. The same problem now exists to varying degrees with several of the other top ten credit card banks. Settle on your own, and you can get settlements ranging from 20% to 50% depending on the bank in question. Use a settlement company, and expect to see 60%+ settlements with those same banks.

To be completely fair, there is some truth to this sales claim when they negotiate with smaller third-party debt collection agencies. A lot of the people who do the negotiating for settlement companies are former debt collectors, and they often have contacts with various agencies. They also know the jargon and can comfortably speak with their counterparts at these collection agencies. So it’s possible that a professional negotiator will get a 35% deal with a collection agency where a consumer on their own will get a 50% deal instead.

But – by the time you add back the 15% fee charged by the settlement company – you’re right back where you would have been anyway.