Charles Phelan

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.

The latest big news in the world of debt and credit is the IRS’ attack on the credit counseling industry. The IRS has canceled the tax-exempt (non-profit) status of some of the largest counseling agencies in the industry. A total of 41 organizations have had their non-profit status revoked, and this represents about 40% of the industry’s revenue. There are at least 740 other agencies that have not yet been audited, so obviously the IRS has concentrated first on some of the bigger players.

IRS Commissioner Mark Everson said, “These organizations have not been operating for the public good and don’t deserve tax-exempt status. They have poisoned an entire sector of the charitable community.”

In addition, the IRS has become very strict on approvals for new applications for non-profit status, with 97 out of 100 such applications rejected.

For more detailed information, here is one version of the basic article that was published online by numerous news sources.

What I find most interesting about all this is the widespread misunderstanding over the concept of non-profit. The tax exempt status associated with non-profit organizations was originally intended to help charitable institutions. So the concept of “non-profit” has been associated in the mind of the average person with “charitable,” i.e., “free.” Yet credit counseling services, even legitimate ones that satisfy the IRS’ criteria for tax-exempt status, are NOT free to consumers. There are always signup fees and monthly fees involved, and these agencies also receive significant compensation directly from the clients’ creditors. Money changes hands. Fees are collected. Sounds like a regular business to me.

But the term “non-profit” makes a powerful impression in the mind of the average consumer. So it’s no surprise that numerous companies have attempted to exploit this association for marketing purposes and monetary gain.

What’s lost in all this though is a deeper question: Why should credit counseling services, or any companies that offer debt management services (including debt settlement), operate under the non-profit model? Last time I checked, this was still America, where it’s ok to MAKE A PROFIT. Whenever any government official discusses this topic, they always refer to “for profit” companies as though they were guilty of some terrible sin. So I ask the obvious question: What’s wrong with (a) helping consumers tackle their debt problems, and (b) making a profit while doing so? Why is this such a bad thing? Consider that companies making a profit can afford better staff, better training, and better equipment. Yes, of course there are bad actors out there that are only in the business to soak the consumer, but just because a company chooses the for-profit model does not automatically place them in that category.

What it really comes down to is this: Most government officials are totally clueless with respect to what it takes to run a successful business in a highly competitive industry. So they automatically assume that anyone who sets up a business to assist consumers while actually managing to make some money in the process must be bad by definition. But there is a major flaw in this logic, in that it completely overlooks the business practices of the credit card industry itself.

Credit card banks operate with impunity and have created a system that preys on the financially disadvantaged. Do we see regulatory scrutiny or enforcement actions against the major players in that industry? No. So I guess the real message is this: It’s ok for the credit card banks to make billions in profit on the misfortune and financial depredation of distressed consumers (think punitive late fees, overlimit fees, 32% interest rates, etc.), but it’s NOT ok for companies to make a profit while trying to help consumers deal with those very same creditors. What’s wrong with this picture?

With all the news these days about identity theft, it’s important to examine your credit report for errors at least once or twice per year. If you’ve been using credit for, say, 10 years or more, the odds are high that you’ll see older accounts still listed on your reports, even though you haven’t used those accounts for several years or more. This commonly happens when you purchase items like furniture, stereo equipment, or appliances through a store’s financing plan. You may have long since paid for the goods in question and never used that account to finance anything else, yet the account still shows as active on your credit file. The typical consumer’s reaction is to request via the original creditor or the credit bureaus that such older accounts be deleted. But don’t be so hasty. This could be a potentially serious mistake.

If there is nothing negative about the credit history associated with those inactive accounts, then having them deleted is not only a waste of time, it can also lower your credit score. That’s because deletion of an older account can reduce the average duration of the accounts listed on your credit file, which might make it appear that your credit history is shorter than it actually is. Since a longer credit history is better, you could end up with a lower score after the unnecessary deletion.

Also, by removing the older accounts, you’re also deleting the credit limit associated with them, which in turn may drive up your debt-to-credit ratio. This could also have a negative effect on your credit score. So be cautious in requesting the deletion of inactive accounts that form part of the overall positive history on your credit file.

Imagine that you loan someone $10,000 with the understanding that they will pay you back on a monthly basis with interest. After a while, they fall behind on their payments, so you call them to discuss their financial status and encourage them to make a payment. But they dodge all phone contact and you’re not sure they are even getting your messages. No return phone calls. No contact. Nothing. Then you receive a letter in the mail that says something like this: “Pursuant to my consumer rights under the Fair Debt Collection Practices Act, I hereby demand that you cease and desist from any further attempt to contact me by telephone. Any further attempts at telephone contact will result in my taking legal action against you for violating my rights under Federal law.”

What would you do in this situation?

1. Meekly go away and make no further attempt to collect?
2. Ignore the demand and continue calling anyway?
3. Turn it over to a collection attorney?

The smartest thing to do in this situation would be to file a lawsuit against the debtor. When you look at it this way, it seems obvious that sending a cease communication notice to a creditor is a pretty dumb thing to do. It makes no sense at all if your goal is to work out mutually agreeable settlement arrangements with your creditors. Yet there are hundreds of debt settlement companies out there still using this obsolete and dangerous technique, not to mention countless debt information websites that recommend this approach and even provide sample letters.

When I first started doing debt negotiation in 1997, I worked hard to get the creditor to substitute my phone number for that of the client, so cease communication notices were rarely necessary because the creditor could contact me for an update any time they wanted to. I would only use cease communication notices with truly abusive creditors, the ones who refused to respect the rules and continued to harass or abuse the client even though they had received my power-of-attorney to speak on the client’s behalf.

Fast forward a few years. In the process of developing the operational procedures for a large debt settlement operation that handled thousands of clients, it became obvious that we would need an army of people just to field the auto-dialed calls from the creditors. Instead of this unworkable solution, we made the decision to coach consumers on how to screen the calls, report abuse, and generally tough out the collection process until we could negotiate realistic settlements on their behalf. This worked fine, and cease communication notices were usually unnecessary. Unfortunately, many other companies took the easy way out and simply sent out “C & D” letters to every creditor in the client’s file. This was done automatically, and without any analysis with respect to the frequency of the calls to the client or the nature of those calls. The result? A bunch of really angry creditors, a big increase in lawsuit activity (what other choice was the creditor given?), and a lot of unhappy clients.

Sadly, years later many companies and websites are STILL using or recommending this technique. Type “cease communication notice” into your favorite search engine and be amazed. I just did it and turned up more than 1.5 million hits!

Sending a letter like this is the exact OPPOSITE of the approach that I teach. What works best is communication in good faith. This is simply a matter of common sense. I’m not saying that you should subject yourself to abuse or harassment. But in that type of situation, a complaint letter is often more effective than a cease communication request anyway. Obviously, you also need to take measures to manage the volume of collection calls, which is simply a matter of screening. But it’s important to keep your creditors informed, let them know you haven’t disappeared or tried to skip out on your obligation, and that your intentions are to work things out when you have the resources to do so. Patient persistent explanation of your situation will win the day in the end.

It’s pretty simple, really. If you want to settle with your creditors, talk to them once or twice per month until you work out a deal. If you want to get sued, send a cease communication notice.

If you’re in a type of business that’s subject to government regulation (designed to protect consumers from some of the more abusive practices of your business model), and you don’t like one or two of the laws, just spend a bunch of money lobbying Congress and presto — no more pesky consumer protection laws to worry about. That appears to be what’s going on in the latest Congressional chicanery designed to stick it to the consumer.

The purpose of the legislation in question (already passed in the House and presently under consideration in the Senate) is to make check diversion companies exempt from the Fair Debt Collection Practices Act. A check diversion company is basically a collection company that partners with local District Attorney offices to go after people who’ve written bad checks. Essentially, these private debt collectors are allowed to pretend they work for the public DA when calling or dunning consumers for restitution on bounced checks. Until now, these outfits were regulated under the FDCPA like any debt collector. If this legislative amendment passes, such companies will be exempt from debt collection law. The industry was already rife with deceptive practices and abusive fees. Now, of course, it will get worse — much worse.

Yes, of course you should never write a bad check, and anyone who does it on purpose is an idiot that deserves to get hounded by debt collectors. But this debate is not about the need for personal responsibility. Rather, it’s a debate about the too-comfortable relationship between public officials and private enterprise. Ask yourself whether it makes any sense at all to:

1. Allow private debt collection companies to pretend they work for the DA’s office, using DA letterheads and threatening criminal prosecution when no evidence of fraud has been presented or documented.

2. Allow DA offices to receive compensation from said private companies.

3. Allow check diversion companies to harass consumers with no regulatory restraint on tactics or techniques.

4. Punish (through excessive fees and bogus threats of criminal prosecution) financially challenged consumers who may make the occasional mistake in balancing their checkbooks, or who run their budget so close to the bone that slip-ups are bound to occur once in a while.

The National District Attorneys Association, according to its president, Paul Logli, supports the exclusion of check diversion programs from the FDCPA in order to “protect prosecutors and check-diversion companies from lawsuits.”

Excuse me? Why do we need to be protecting collection firms from lawsuits? Aren’t they big boys? Can’t they stand the heat? What a silly argument. Sure, okay, DAs are overworked by definition. But out-sourcing and allowing private companies to impersonate DA staff? Come on. What’s wrong with this picture? Did I mention that the DA offices also make a profit on the check diversion deals? This whole deal smells pretty rotten.

You know, I often tell my stressed-out clients that we don’t have debtor’s prisons here in the U.S. anymore. I’m starting to wonder how long it will be before I can no longer say that.