Charles Phelan

When Congress passed the bankruptcy reform bill last year, they included Section 1229, which asked the Federal Reserve Board to conduct a study to determine whether the “indiscriminate” extension of credit to consumers had contributed to the increase in bankruptcy filings.

The report is a treasure trove of fascinating little tidbits of information. Here are a few examples:

1. In 2004, 71% of American families held general-purpose credit card accounts, up from 16% in 1970.

2. 56% of families carry a balance on bank-type credit cards, and 24% hardly ever pay balances in full.

3. As of 2004, outstanding debt on credit cards was $645 billion.

4. An average of 8.9% of families were late at least 60 days on a debt in 2004.

5. Profitability of credit card banks is nearly double that of commercial banks.

6. More than 5.2 billion credit card solicitations were mailed in 2004, up from 2.7 billion in 1995.

7. The response rate on credit card solicitations has dropped from 1.4% in 1995 to 0.4% in 2004.

There’s a lot more in the report, but the above gives the flavor of the type of data published by the Fed about the credit card industry.

Predictably, the report produced by the Fed concludes that the credit card banking industry is not to blame for the increase in bankruptcy filings. Specifically, “…this review finds that as a matter of industry practice, market discipline, and banking agency supervision and enforcement, credit card issuers do not solicit customers or extend credit to them indiscriminately or without assessing their ability to repay debt.”

Did we expect anything different from the Federal Reserve? Not really. Frankly, the study was simply not deep enough to penetrate the real issues at hand. If the banks are so good at determining repayment ability, then why do I keep talking to people who have far more credit than annual income? Why do the credit card banks make more than 30% of their profit from the delinquent status of their customers (late fees or penalties)? Since the only income data they gather is what’s on the application, how on earth do the banks determine ability to repay in the first place?

To be sure, the report does state that “…certain specific industry practices of late have been deemed by regulators to potentially extend borrowers’ repayment periods beyond reasonable time frames and have been the subject of extensive supervisory attention and guidance.”

Translation: It takes 20 or 30 years (if not longer) to pay off balances via minimum payments, which results in a situation most of us would simply call “highway robbery.” So the Office of the Comptroller of Currency has forced the banks to increase their minimum payment levels and bring down the repayment period.

Where the Fed report gets really interesting though is the conclusions regarding the bankruptcy trend. After citing several economic studies, some of which contradict each other, the report states that “…the longer-run trend in bankruptcy filings is historically related to a number of factors, including an increase in revolving consumer credit use and, perhaps, a decline in the stigma associated with bankruptcy. It also appears that the decision to declare bankruptcy is typically triggered by unforseen adverse events such as job losses or uninsured illnesses.”

Oh, so THAT’s why all those people file bankruptcy every year? I never knew it was because they have more debt, they lose their jobs, or they get injured. How could we have known?

Seriously though, the Federal Reserve report clearly shows a correlation between consumer bankruptcy filings and the inflation-adjusted amount of revolving credit per household. At the same time, it concludes that the credit card banks have nothing to do with this. So if I have this correctly, the Fed is saying that increasing consumer debt has contributed to the increase in BK filings, but the banks do a good job of managing credit risk so the increase in debt which led to the increase in bankruptcies is not their fault. Am I missing something here?

ZipDebt is an idea that I had after leaving my position as an executive with a large debt settlement operation. The idea is simple enough: Why can’t people do this themselves for a fraction of the cost?

The name is itself is nothing special. I wanted an Internet domain name that would be short, easy to remember, and contain the word “debt.” Unfortunately, just about every possible permutation was already taken – again, because there are a zillion debt websites. But “ZipDebt” gets the point across. “No Debt.” That’s the goal.

Anyway, the idea behind the name is to provide the American consumer with a NEW debt resolution option: The do-it-yourself-with-coaching program — affordable, effective, and different from what anyone else in the debt industry is doing or offering.

Most of the existing solutions don’t work. Borrowing against equity is often a trap. Credit counseling has a documented failure rate of 75%. Chapter 7 Bankruptcy is more difficult to qualify for, and Chapter 13 Bankruptcy is a much tougher program after the new law went into effect in October 2005. Debt settlement companies are up against increasing regulatory pressure and creditor backlash in a simultaneous squeeze play against the industry. Plus the fee structure of the industry is simply not in the best interests of the consumer. (See my earlier post on this subject.) Yet the mathematics of debt negotiation and settlement (minus the fees) makes a lot of sense for a wide variety of financial hardship cases.

So I recorded my Debt Elimination Success Seminar and established this website to offer it for sale, initially selling only the seminar without any coaching. After a while, I started getting questions from customers. Although I made the audio seminar as comprehensive as possible, every situation is different and collectors are pretty good at scaring people. So I started getting a lot of emails for follow-up advice. Hence the idea of coaching folks by email, which has worked out very well. You can see some of the more recent results in later posts on this blog.

Lately, I’ve shifted the emphasis a bit, from an audio-seminar that includes some coaching to a coaching program that includes a training seminar. More and more clients have told me that the seminar is great, and it really helps them to understand the whole negotiation and settlement process, but it’s the coaching they find invaluable. When you consider that the cost of the coaching program is well under 10% of what most settlement companies charge, it certainly makes sense to negotiate on your own (with help from yours truly). It means you can get out of debt much faster, since all your resources are going toward getting rid of debt and not toward fees. I should add that I really have nothing against the settlement companies. It’s just that it makes more financial sense for consumers to do this on their own.

If you have questions or concerns about this approach, then please feel free to request a free 20-minute phone consultation with me.

Recently, I ran across a website that purported to show consumers how to set up a new credit file. Here’s a direct quote: “Now, you can set up a brand new credit file, totally separate from your existing one. This process of achieving AAA credit, with your new credit file, takes less than 30 days & not only is this 100% LEGAL, it’s your RIGHT!”

Just to set the record straight, this is a LIE. There is NO legal means of establishing a new credit identity. For someone with a poor credit history, stuck with high interest rates or unable to get credit at all, an offer like this can seem pretty attractive. However, the creation of a new credit identity is illegal, period. The practice is called “file segregation,” and the scam involves the use of a 9-digit Employer Identification Number (EIN) or Tax Identification Number (TIN) in place of the regular Social Security Number.

If you are tempted by one of these schemes, DON’T DO IT! Even if you are foolish enough to break the law, it’s simply not worth the risk. That’s because it’s only a matter of time before the two separate credit files merge. When that happens, the credit bureaus will place a nice big FRAUD flag on both files, and you will never get credit again for anything — ever. That would be the best-case scenario. Under the worst-case scenario, you could be looking at jail time, civil fraud penalties, or both.

Here’s what the Federal Trade Commission website has to say regarding this practice:

“It is a federal crime to make any false statements on a loan or credit application. The credit repair company may advise you to do just that. It is a federal crime to misrepresent your Social Security number. It also is a federal crime to obtain an EIN from the IRS under false pretenses. Further, you could be charged with mail or wire fraud if you use the mail or the telephone to apply for credit and provide false information. Worse yet, file segregation likely would constitute civil fraud under many state laws.”

Until the government started throwing people in jail for selling bogus file segregation programs, scammers were routinely charging $3,000 and up for this “service.” Nowadays, you probably won’t find anyone stupid enough to offer such an illegal service directly. Instead, the game is to sell eBooks for $25, $50, even $150 that explain how to set up a new credit identity. Naturally, they put disclaimers on their websites that the program is only sold for “information” purposes, and other fig-leaf phrases designed to protect them from legal blowback. This still qualifies as a scam in my opinion, because the true facts are not being disclosed and consumers are being ripped off thereby.

There are also numerous websites promoting a newer variation on this scam, which involves obtaining a brand new Social Security Number. Because there is no EIN or TIN involved, they claim that this makes it legal. Wrong. It’s still fraud. According to the Social Security Administration website, a new social security number (which is sometimes issued in cases of ID theft) cannot be obtained if the intent is to avoid the law or legal responsibilities.

So any attempt to obtain a new SSN for the purpose of creating a new credit file does not constitute a legal or valid reason. Also, what the promoters of this technique neglect to point out is that the original purpose of your Social Security Number is to track your earnings contributions into the Social Security program. If you set up a new SSN, how will you receive the benefits to which you are entitled under the original number? If you have been working for any length of time, this could cost you plenty in the form of lost Social Security retirement benefits.

There are indeed legitimate ways to improve your credit. However, trying to game the system by setting up a new credit file is definitely not the way to go.

A recent article in the St. Petersburg Times, “Buyers Give Old Debts New Life,” provides a revealing look at the problem of “zombie debt.” (See my blog post of 5/19/06 on this subject.) In the debt industry, zombie debt is debt that is past the Statute of Limitations for collection through the court system. This is also called “time-barred” debt, because it has aged past the point where collection can be forced by legal means.

Let’s dispel one important myth about zombie debt right away. It is not illegal, or a violation of the Fair Debt Collection Practices Act, for a creditor to bring a lawsuit on a time-barred debt. Just because the debt has aged past the Statute of Limitations does not mean that a creditor will never sue to collect. Rather, it is up to the person being sued to assert the time-barred status of the debt as a defense. If this can be documented, then and only then will the suit be dismissed under the Statute of Limitations. Many debtors become complacent on this point, and are surprised to see lawsuit activity on older accounts. (Although the majority of debtors are not even aware of the Statute of Limitations in the first place!)

Another important point to bear in mind when dealing with old collection accounts is to ensure that you are looking at the correct Statute of Limitations. The statute period varies from one state to the next. So you have to check the rules for your specific state rather than rely on the generic “4-6 years” commonly cited. Further, there are different types of statute: one for written contracts, one for verbal contracts, another for promissory notes, and still another for open-ended accounts. It’s the latter category (open-ended accounts) that is typically the statute that applies in the context of revolving debt, with credit card debt as the single most important category of revolving debt. It’s crucial to bear in mind that some states use the same statute period for all four types of contract, where others have different statute periods for the different types of debt. This can often make a HUGE difference in the status of an account. For example, in Ohio, the SOL for a written contract is 15 years! Yet for open-ended debt (credit cards) it’s only 6 years.

One more thing to consider: The game in collecting zombie debt is to trick the debtor into making a small payment to get the pressure off, or transferring the balance to a new account (under the lure of improving their credit score). Both of these moves can be deadly. Why? Because ANY payment activity starts the Statute of Limitations all over again! It doesn’t matter if the debt is from 1950. If you make a payment, you reset the clock and the debt is no longer time-barred.

The above warnings notwithstanding, I do not take the position that the debt purchasing industry is “evil.” Some consumer advocates describe such companies in very derogatory terms. Others recommend that debtors never settle their debts with such companies. In my opinion, these are naive and dangerous recommendations. Call this industry evil if you want to vent, but that won’t prevent the damage that comes from ignoring their collection claims. By telling consumers to never settle debts with debt purchasers, some consumer advocates are setting up those debtors for serious trouble. If you are past the Statute of Limitations, that is one thing, and there is really very little point in settling an account that is “time-barred.” If the statute period has not expired, however, ignoring collection activity is a risky proposition. This is one reason I am so adamantly opposed to bogus “debt elimination” programs. The frivolous tactics used by promoters of these techniques succeed at most in getting one company to sell its claim to another. Who wants to keep going to court over the same debt, year after year? It’s better to negotiate a workable agreement and put the matter to rest once and for all.

So I do not think that debt purchasing is an inherently “evil” practice. I DO think there are problems with how the debt purchasing industry documents its claims (poorly in most cases), and also how they calculate current claim balances. I still can’t quite figure out why someone purchasing a debt THAT HAS BEEN PREVIOUSLY CHARGED OFF should be entitled to inflate that charged off amount with interest. Further, I don’t see how they should have the right to inflate it FROM THE TIME OF CHARGEOFF (as many debt purchasers do), when a period of several years may have elapsed between the chargeoff date and the date of purchase. So it’s important to understand the game when you are dealing with debt purchasers. But in my view, debt purchasing provides additional opportunities for debtors to resolve older collection accounts through the negotiation of mutually agreeable settlements.

A new report released by Experian shows that consumer debt levels have increased over the past two years. Based on an analysis of millions of consumer credit files, the average revolving and installment debt has increased from $10,371 in 2005 to $11,669 in 2006. This represents an increase of nearly 13% over the past two years. Installment debt includes auto loans, student loans, or other loans with a fixed monthly payment (excluding mortgages), and revolving debt typically includes credit cards and department store charge cards. Since the 13% figure lumps together both types of debt, we don’t know how much of the increase pertains to credit card debt versus installment debt. But the trend itself represents a significant overall increase in consumer debt levels.

Another fascinating statistic: The average number of late payments has increased more than 19% from 2004 to 2006. Back on March 28, I blogged about my prediction that credit card late payment rates will rise again after an artificial dip caused by the tidal wave of late-2005 bankruptcy filings. Again, this new Experian report lumps together late credit card payments with late payments on installment debts, so we don’t have a precise breakdown, but the overall increase supports my prediction of higher late payment ratios on credit card debt for 2006.

We can draw two general conclusions from this report: Consumers are taking on more debt than before, and they are having a more difficult time managing that debt. Add to the mix an increase in home foreclosures, plus a negative savings rate, and it’s hard to be optimistic about the financial future of the American consumer.

A debt purchasing company has been sued by Illinois’ Attorney General — Lisa Madigan. The suit alleges use of illegal collection tactics by the firm. A detailed press release on this latest enforcement action against the collection industry is available here.

Financial Credit Service, Inc. has allegedly been using intimidation tactics to pressure people into making payments on debts that would otherwise be uncollectible. Why are some of the debts uncollectible? Because the debts in question are “time-barred,” meaning the statute of limitations has expired. Beyond this period of time the creditor (either the original creditor or the firm that has purchased the account and become the new owner) can no longer pursue legal remedies to collect on the debt. Over the last 10 years, the business of debt purchasing has grown into a multi-billion dollar industry, with dozens of major players and hundreds of smaller firms getting in on the action. The game? Buy old debts for pennies on the dollar, hammer people for payment using high-pressure collection tactics, and make a profit on the investment.

Since it’s very difficult to collect on debts that are past the statute of limitations, a favorite tactic of such firms is to trick consumers into making a small payment through intimidation and pressure. This resets the clock on the statute of limitations and makes the debt fair game again for regular collection procedures.

In this particular case, the AG’s suit alleges that the company had even tried to collect on debts that had already been discharged in bankruptcy. Also, when consumers requested verification of the disputed debts in accordance with the Fair Debt Collection Practices Act, the firm refused to respond to such requests or claimed that a fee would be required to provide such information. There is a laundry list of other violations alleged in the AG’s complaint.

It all reads like “business as usual” in the world of zombie debt collection. This is a growing problem that will only get worse as the debt purchasing industry grows in size.

My advice to consumers dealing with collection activity on old debts: First, look up the statute of limitations for your state. Be sure to account for differences in the statute between credit card debt (open-ended accounts) or financial contracts (written contracts), so you know which category your account falls into. Second, look up the date of last payment you made or the last transaction activity on the account. Third, add 30 days to that date to be on the safe side. Then count forward from there to see where you stand on the statute of limitations.

If the debt is time-barred, then you can safely ignore any threats made by collectors. Be aware, however, that such a firm might still bring a frivolous lawsuit. In that event, you will need to answer the suit and show that the debt is time-barred. The absolute wrong thing to do is to make a small payment. This will only remove the protection of the statute of limitations and leave you open to further collection activity.