Charles Phelan

So far for 2007, it’s been very busy here at ZipDebt – hence the infrequent blog posts over the past few months. One of the reasons for the increasing number of people seeking help with credit card debt is the subprime mortgage problem that’s recently been in the news.

After seeing countless people buy $700,000-$800,000 homes here in the San Diego area, and scratching my head as to how average people could possibly afford such huge mortgages, it’s now becoming quite clear that many of these folks never really could afford those expensive homes in the first place.

There’s a reason why conservative lenders still use the old 28/36 rule for debt-to-income ratio analysis. Your housing expenses (mortgage principal + interest + property taxes) should not exceed 28% of your gross income, and your total debt payments (housing + auto loans + unsecured obligations) should not exceed 36% of your gross income. When the ratios climb much higher than that, people have to start borrowing more just to stay afloat, and the household budget becomes very unstable.

So I’ve been hearing from quite a few people lately who are trying to get out from under properties that are at risk of foreclosure, after the payment on their adjustable-rate mortgage (ARM) increased to the point where they can no longer handle the higher payment on top of their existing credit card bills.

Adjustable mortgages are potentially risky enough. But I can’t how imagine anyone in their right mind would take on a “creative” mortgage, like the 1% loans that were a staple of the subprime market last year. With real mortgage interest rates at 5%, how could a 1% loan even exist? Well, it’s called negative amortization, where you make your payment but you end up owing more at the end of the month that you owed at the start of the month. That’s because the payment does not even cover the full amount of interest on the note, so the amount you owe climbs with every payment. It would only make sense to consider such a loan if you were 100% certain that the value of your property were going to appreciate much faster than the increasing debt associated with the negative amortization. And plenty of people who got into such loans assumed just that — they expected the steep rise in home prices to continue. “Hey, no problem. Our equity will be up $100,000 in a year or two, and we’ll just refinance and get a regular mortgage.”

In investing, this is called “the greater fool theory,” where a person pays sky-high prices for an investment because they are convinced a bigger fool will come along and pay an even higher price. But such run-ups never continue indefinitely. Eventually, conditions change and the market flattens out or even crashes. We haven’t seen an actual crash in the real estate market yet, but we’re certainly seeing downward pressure on prices as foreclosures mount across the country.

Add $30,000, $50,000, or $100,000 of credit card debt on top of a ballooning mortgage payment, and you have a fast track to financial disaster. I expect debt companies will have trouble keeping up with the flow of new clients as we roll forward through 2007.

Continuing our multi-part discussion of “Crazy Stuff Collectors Say,” I’ll focus in this post on a technique that frequently comes up in collection calls. I call it the “fraud” tactic. The collector may something like the following:

“Look, you knew when you used this credit card that you were not going to be able to pay. You’ve committed fraud against our client. Unless you make a payment today, we’re going to recommend that our client go after you for wire fraud.”

The FDCPA prohibits debt collectors from making false statements, including the false implication that you have committed a crime in failing to repay a debt. A debt collector simply has no way to determine what your intentions were at the time you made a purchase on your credit card. Nor are they legally qualified to determine what is or what is not a criminal offense. So this is actually a clear violation of the Fair Debt Collection Practices Act, yet it’s a tactic that is used frequently by debt collectors.

How should you respond to such a threat? I normally recommend that you try to work with your creditors in order to resolve your debt problems. And I also recommend that you work through their assigned collection agencies when necessary, which usually happens after an account has passed the point of charge-off. However, this assumes that agency representatives behave in a reasonable fashion and stay within the confines of the rules for debt collection. In other words, you should work in good faith with those collectors who are doing their jobs correctly. However, if a debt collector is prepared to falsely accuse you of a crime, there is simply no reason to continue the conversation any further.

So here’s one way to handle the bogus “fraud” accusation:

COLLECTOR: “Unless you make a payment today, we’re going to recommend that our client go after you for wire fraud!”

YOU: “May I have your full name, please, as well as the name and address of your agency?”

COLLECTOR: “Why do you want that?”

YOU: “So I can make sure I spell your name correctly in my complaint to the Federal Trade Commission and my state Attorney General. You just accused me of committing a crime, which means you violated the Fair Debt Collection Practices Act. Failure to properly identify yourself and your company is another violation. What is your full name, please, as well as the name and address of your agency?”

At this point, many collectors will just hang up the phone rather than continue the game. Or they may dig themselves in deeper by getting angry or belligerent.

If you feel a collector has crossed the line then you should definitely go forward with your complaint. You can file complaints against debt collectors online at the FTC website. You should also file a complaint with the Attorney General in your state as well as in the state the collector is located. I don’t recommend you complain formally unless you have good cause, but it’s important for consumers to stand up for their rights, and one way to do that is to ensure that the proper authorities are informed when a debt collector crosses the line and becomes abusive. And by any standard, a false accusation of criminal intent is certainly an abusive tactic that should not be ignored.

There has been a lot of media attention regarding the recent Congressional hearings on practices of the credit card industry. One of the subjects receiving coverage is the “universal default clause,” which consumer advocates have vocally complained about for years. This insidious provision is buried in most credit card agreements, and it permits a credit card bank to raise your interest rate sky-high if you default on payments to a DIFFERENT company.

I have in front of me a credit card agreement from one of the top ten card issuers. Here is the offending language:

“We may change the rates, fees, and terms of this Agreement at any time for any reason. These reasons may be based on information in your credit report, such as your failure to make payments to another creditor when due, amounts owed to other creditors, the number of credit accounts outstanding, or the number of credit inquiries.”

In plain English, a credit card “agreement” is not a true agreement at all. It’s a totally one-sided practical joke, and the victim is the consumer. Aside from needing an electron scanning microscope to read the fine-print, and a law degree to understand it, the language is totally in favor of the creditor and offers very little protection to the consumer against predatory banking practices.

The universal default clause is bad enough. But it gets worse, and that’s what I want to focus on in this post. Lately, I have been receiving a lot of consultation requests from consumers complaining about steep increases in interest rates, WHEN THEY HAVE NOT BEEN LATE WITH ANY CREDITOR. What gives?

This is a little-known problem, and you don’t hear about it much in the media coverage of credit card practices. While there is some slight justification for placing consumers in a higher-risk category (which results in higher interest rates) if they start falling behind on payments to other creditors, what could possibly justify an interest rate increase when there have been no missed payments to anyone?

The technical concept underlying this industry practice is called the “credit utilization ratio.”

Let’s say you have a total of $30,000 of credit available to you on three different cards, each with a $10,000 credit limit. Now let’s say you are carrying a balance of $4,000 on each card, for a total of $12,000 of debt balances. So far, so good. You are using $12,000 of credit against a total available limit of $30,000, which yields a credit utilization ratio of 40%. As long as your ratio is below 50%, then generally this will not be a problem or negatively impact your credit score. But what happens if you have borrowed $27,000 against the available $30,000 limit? That puts your credit utilization ratio at 90%. While it’s hard to determine the exact ratio that triggers interest rate increases, there’s no question that a 90% ratio will cause problems. The FICO score will probably drop, and worse, the creditors may jack up interest rates to the default rates of 28-32%.

Due to the method by which most banks now calculate minimum monthly payments, the above scenario is a recipe for financial disaster. Let’s say you have been struggling along to make the monthly minimums, even when the interest rates were under control. Most banks now calculate interest rates based on a formula of 1% of the debt balance plus the finance charge for that month. So on a balance of $10,000 at an interest rate of 15%, the minimum payment under this method would be $225. But if the interest rate suddenly jumps to 30%, the minimum payment would jump to $350! Multiply this effect across several credit card accounts, and it’s easy to see why many people are pushed over a financial cliff as a consequence of this practice. Remember, it has nothing to do with being late on any of the accounts. This situation can develop even if you have never missed a single payment! The banks justify this practice by claiming that consumers with high utilization ratios are at higher risk of default. Nothing is said about how the industry practice of raising interest rates actually contributes to an increase in defaults.

So the message is clear. Keep your overall use of credit below 50% of the total amount of credit available to you on unsecured credit cards and loans.

The Office of the Comptroller of Currency (part of the U.S. Federal Government) has published a statement on debt elimination scams. It’s an excellent piece that confirms everything I’ve been saying about these bogus techniques. The OCC refers to these as just the latest in a long line of “advance fee” schemes, where you pay through the nose up front for assistance with your debt problem in the form of a loan or a service, only to find that the loan is denied or the service doesn’t work out. In fact, it’s such a clear statement of the facts that I’m going to post the entire article below without further comment:

OCC Debt Elimination Notice

The Office of the Comptroller of the Currency (“OCC”) continues to see an increasing volume and variety of fictitious debt elimination schemes being perpetrated against financial institutions. These fictitious schemes are not to be confused with debt consolidation or debt workout programs presented by legitimate entities.

The object of legitimate programs is to assist the borrower to repay the debt in a responsible manner. The fictitious schemes claim to be able to “eliminate” or to “cancel” various types of debt from banks and non-banks without a material further amount of payment by the obligor. The fictitious schemes take various forms, including those that:

claim to pay out the debt in some way, but don’t;

transfer the debt to some wealthy benevolent entity, that does not exist or has no financial capacity; or,

falsely claim to be able to have the debt declared invalid for the reason that the financial company is not permitted to lend money or the documentation used by the lender is not valid.

The fictitious, fraudulent schemes are being marketed to everybody, not just the wealthy or sophisticated, including borrowers who are current and those approaching foreclosure. The underlying fraudulent claim in all these fictitious schemes is:

a debt can be eliminated or canceled simply by paying someone a small fee relative to the amount of debt to be eliminated.

These schemes are promoted: via the Internet; in seminars throughout the United States; and, directly by persons known to the victim by way of group affiliation, particularly religious and fraternal groups. These fraudulent schemes claim to “eliminate” or to “cancel” various types of debt, including mortgages, credit card balances, student loans, auto loans, and small business loans. All of them are simply designed to take an individual’s money, and are just the modern version of the old “up-front-fee” scheme. The schemes charge an up-front fee, or membership fee, that currently ranges from $400 to $7,500.

As a result of using a fraudulent scheme, individuals will lose money, could lose property, will damage their credit rating, and possibly incur additional debt. In addition, a creditor may take legal action against an individual to resolve a fraudulent attempt to eliminate debt. It is also possible for the victim to have identity theft occur by participating in a fraudulent scheme. The perpetrators of these schemes are known to steal identities and create substantial new debts in the victim’s name before they are even aware that it has occurred. It is extremely difficult and time-consuming to resolve the issues pertaining to identity theft.

These fraudulent debt elimination and cancellation schemes have no substance in law or finance. In statements and sometimes in the guise of education, the perpetrators of the schemes provide inaccurate or distorted information about applicable laws and real financial operations. The following are examples of inaccurate information the OCC has seen from these schemes:

Secret information or laws, known only to a select few, can be used to eliminate debt;

Banks and other creditors do not have the authority to lend money, to advance credit, or to charge interest;

An individual’s debt is a asset of the creditor that the creditor owes to the individual;

A debt owed to a bank is the same as a deposit in a bank;

Creditors will not pursue debt collection after an individual participates in one of these schemes;

The United States Department of Treasury or some other Federal agency establishes a trust account when an individual is born;

Arbitration need not meet the terms of the credit agreement;

Individuals can create their own arbitration companies that can create and certify arbitration awards that eliminate, cancel or reduce debt;

An individual does not have to pay the debt because the contract or note is illegal and may even deserve a compensatory award; and,

Results are guaranteed.

There are unlimited variations to these schemes. The basic idea of these schemes, however, is to fool individuals into paying money to have a debt eliminated or cancelled, or to obtain false documents and the instructions on how to submit the false documents to creditors. The following are some variations of the false documents used:

A fake arbitration award from an arbitrator not authorized under the debt agreement;

A worthless debt instrument issued by some company, group, trust, benevolent society, or wealthy individual, quite often of foreign origin, as a substitute for the creditor’s note;

A record of a fictitious account or “trust account” supposedly held in an individual’s name at the United States Department of the Treasury or other Federal agency;

A fictitious U. S. Government debt instrument issued as a substitute for the creditor’s note, payable through an agency or by an authorized agency person;

A notice, usually voluminous, to the creditor stating that the contract or note is illegal or the creditor does not have authority to “advance credit” and has violated the law; or,

The issuance of a false payoff certificate from the original lender, combined with the borrower’s authorization for the perpetrator to obtain a new mortgage, using the proceeds to pay the perpetrator’s fee. This “new debt” is stated to be a new first lien, but it is really just a second mortgage, thereby increasing the victim’s debt and monthly payment requirements.

Any information that you have concerning fraudulent debt elimination or debt cancellation schemes should be brought to the attention of appropriate local or Federal law enforcement personnel.

If the fraudulent scheme is presented via the Internet or e-mail, contact the Internet Crime Complaint Center (IC3). Please go to the IC3 Web site at https://www.ic3.gov and follow the instructions for filing a complaint (IC3 was f/n/a the Internet Fraud Complaint Center- IFCC). Contacts from other sources, such as individual contacts or seminars, should be reported to the local office of the FBI and your local financial fraud law enforcement organization.

If any portion of the offering or subsequent portions of the transaction are processed through the United States Postal System (USPS), the Criminal Investigation Division of the USPS should be contacted. Contact information can be obtained from your local U.S. Post Office.

Continuing our discussion of collection pressure tactics, I’ll focus on the “refusal to pay” tag-line frequently used by debt collectors.

Let’s say you’ve explained to a debt collector that you’re in a financial hardship situation and can’t make any payments. For the purpose of this discussion, it doesn’t really matter whether or not you’re actively trying to settle the account. Whatever your situation or intention, the goal of every debt collector is to extract a payment from you RIGHT NOW, usually by getting you to give them your checking account info so they can process an electronic debit. If the collector is not able to get a payment commitment from you, they may adopt a harsh accusatory tone and use the following line:

“Fine, then I’m going to note down here in your file that you are REFUSING TO PAY.”

Another variation on this line makes it sound even more threatening:

“Fine, the we’re going to report to our client that you are REFUSING TO PAY, and recommend they take aggressive action to collect this debt.”

Now, this statement about “refusing to pay” really gets people agitated. It’s an accusation and a threat all at the same time, and people get riled up when their personal honor is attacked like this. So what does the average person do? They fall right into the trap, by saying something like, “But I’m not refusing to pay!”

Then the collector can move in for the kill with, “Fine. Then let’s take care of this right now. Get your checkbook out and read me the string of digits along the bottom.”

There are several ways to respond to this type of “guilt-trip” pressure tactic. I’ll break it down into three different possible responses to the “refusal to pay” accusation. Choose whichever technique fits your personality and temperament:

1. Don’t even bother responding. Just hang up the telephone. It’s not necessary to have the last word on collection phone calls.

2. Respond in a very calm tone of voice, “I can see that you are going to make false statements about me to my creditor no matter what I say. So I guess we’re done here.” Then end the call. If you let the collector know they aren’t going to get under your skin with this type of approach, they will be less inclined to try it again later.

3. Take a more officious tone, and say the following: “OK, I can see that you are prepared to make false statements about me in my file. I intend to file a complaint with the Federal Trade Commission and the Attorney General about your fraudulent business practices. I’ll be naming you personally in the complaint. Have a great day!” Then hang up with no further dialogue.

I generally recommend against getting into an adversarial conversation with debt collectors, since it’s usually counter-productive. However, once in a while, you need to give as good as you get. Once a collector realizes that you cannot be bullied, intimidated, or made to feel guilty, most of their grab-bag of tricks goes out the window and you can have a more productive conversation about resolving the situation.

I’ve been involved in the debt settlement industry for nearly a decade, and I’m still amazed by some of the crazy stuff that debt collectors tell people. Sometimes it seems like they have nothing better to do than sit around and think up strange or insulting things to tell debtors in order to intimidate them into making a payment, whether or not they have the money.

Incredibly, one of my clients was recently told to “go sell her blood” in order to raise money to make a payment! Another client, who makes her living as a commercial artist, was told, “Maybe you’re just a lousy artist and that’s why you don’t make enough money to pay your bills.” Both of these clients are honest hard-working people struggling to make ends meet like millions of other consumers. They were not in this situation by choice, and they would happily have stayed current on their debts if they hadn’t been hit with unexpected financial distress.

My intention is to blog about some of the pressure tactics that collectors use, in the hopes that people on the receiving end will read these posts and take heart. In this first post about collection tactics, I’ll focus on one of the common myths that is repeated daily on countless collection calls. I’m referring to the concept of “bankruptcy insurance.”

Let’s say you’re trying to negotiate a settlement on an account with a collection agency. You tell the collection rep that you are earnestly trying to avoid a bankruptcy, but you’re simply not in a financial position to make payments, and that you hope to eventually gather enough funds to settle the account. In a rude and condescending tone, the collector says, “Our client doesn’t care if you file bankruptcy. In fact, they would prefer it, so you might as well go ahead. That way they can file a claim against their bankruptcy insurance.”

What the… ? Is there such a thing as bankruptcy insurance? What just happened here?

What happened is that the collector used one of the oldest collection tricks in the book: the psychological removal of any leverage the debtor thinks they might have. You see, most people correctly assume that the threat of bankruptcy is a serious concern to a creditor. But the debt collector doesn’t want you to think that way. They want to mentally remove any bargaining power you think you have. They will try to confuse you and create fear, doubt, and uncertainty. Since most people who are up against aggressive debt collectors eventually mention the B-word, some genius thought up the idea of “bankruptcy insurance” as a way of deflecting and downplaying the threat of bankruptcy.

Folks, there is NO SUCH THING as “bankruptcy insurance.” There are no insurance policies that protect a credit card bank or unsecured lender against losses due to default, simply because there are no insurance companies foolish enough to issue such a policy. Why? Because such losses are predictable to the extent that the cost of the premium would equal or exceed the amount of the losses. The major credit card banks know with a high degree of accuracy what losses they will typically incur on an annual basis. It’s all programmed in as a cost of doing business. Sometimes the results come in slightly above or below expectations. But there is not enough variation for any type of insurance policy to make sense at all.

For insurance to work, there must be a large enough pool to spread out the risk, as with life insurance. When an insurance company issues a life insurance policy, they are betting that you will not die during the period the policy is in force, so they will get to keep all the premium they collect from you. The money they pay out in death claims is exceeded by the premium they collect from all the people who don’t die within the policy period. This could not possibly work in the context of creditor losses because it would be a losing bet for the insurance company unless they charged more for the premium that the expected losses. So if you are a creditor, good luck finding anything that resembles “bankruptcy insurance.”

Anyway, if you’re trying to haggle with a collector and the subject of “bankruptcy insurance” comes up, just laugh and say, “Oh, come on, you’re not really going to try that old trick on me, are you?”