Charles Phelan

OK, here’s the big news today, shouted from several breathless headlines: Bankruptcy Filings at Lowest Level in 20 Years for First Quarter of 2006!

Wow. You might think that statistic means the new bankruptcy law is actually working. The hoopla is over a report published by Lundquist Consulting showing that around 103,000 personal BKs were filed in January-March of this year, versus almost 382,000 for the same period in 2005.

There are two key points I want to make here:

First, total BK filings for 2005 were up more than 400,000 compared to 2004. And much of that increase came in the 3rd and 4th quarters of 2005, right before the new law went into effect. The simple fact is that hundreds of thousands of consumers filed for bankruptcy before the deadline, when they would otherwise have dragged their feet hoping to avoid it. I think we can safely assume than many, if not most, of those extra 400,000+ bankruptcies would have happened in 2006 if the new law had not been a factor. So the first quarter stats are basically meaningless. We’ll need a full year for the impact to be absorbed before we really understand the impact of the new law on the overall number of bankruptcy cases.

The same is true for the ratio of Chapter 7 to Chapter 13 filings. Right after the law went into effect, Chapter 13 cases jumped up to 60%, compared with an average of 29% in prior years. Now it’s down to the 40% territory, and will probably drop even further as the year proceeds. Again, that’s simply because anyone and everyone who could file Chapter 7 did it before the deadline.

The second point, which I have yet to see discussed in the financial media, is the “stealth bankruptcy” factor. What I call stealth bankruptcy is BK without the paperwork. People up against the new BK law will simply move without forwarding their address, dodge their creditors, and default on their obligations without the protection of the courts. I am certainly NOT advocating this approach, but given the tough new requirements it’s simply reality that many people will go this route. So even if the overall numbers for BK filings remain lower in 2006 versus 2004 or earlier (2005 will be a statistical anomaly), that will not mean fewer consumers in trouble.

While I am a big fan of debt settlement as an alternative to bankruptcy, I strongly believe that the do-it-yourself approach works better for consumers than using a professional debt settlement company. I hasten to add that I have nothing against third-party debt settlement companies. Many of them do a good job for their clients, and in fact I personally know a number of the owners and executives in this industry. Most of the criticisms of the industry are misplaced, and are usually put forth by people associated with credit counseling. In other words, the criticisms are usually from a source that is biased at best, and actively hostile at worst.

The critics usually display ignorance when it comes to any understanding of what the debt settlement industry is actually all about. Debt settlement is an alternative to bankruptcy, period. Once this is understood, most of the criticisms miss the mark by a wide margin. For example, it is widely stated that settlement companies “ruin people’s credit.” Excuse me? The client was already there, starting to miss payments, and headed off a financial cliff. I have personally talked with consumers who had more than $100,000 in debt and still had a good credit score. But they had only been able to keep up the $2,500 in monthly payments by using one card to make payments on the others, doing the credit card shuffle until the house of cards came crashing down. What the critics don’t realize is that most people who turn to debt settlement simply cannot keep going down their present path. The money simply isn’t there. They just don’t have the monthly cash flow to make it happen. Criticizing a settlement company for ruining someone’s credit when they are already in this situation is like complaining that a doctor doing open-heart surgery to save a patient’s life will leave a nasty scar behind. It’s simply part of the cure.

If I am in favor of debt settlement and have nothing against the companies providing this service, why do I recommend the DIY approach? There are several reasons, but the one I will concentrate on in this post is FEES. I’m not opposed to companies earning money for their services. I think the whole “non-profit” thing is largely a trick on consumers anyway, and I believe that for-profit companies are in a better position to pay a decent salary to their staff. No, my beef is not with the existence of fees in general. Rather, what I object to is the TIMING of the fees, as well as the sheer SIZE of the fees. Let’s say you owe $50,000 in debt. Most settlement companies will charge around 15% of the enrolled debt, so in this example, that’s $7,500 in fees. Frankly, that’s simply too big a number. But the timing of how those fees get collected makes the problem even worse. That’s because most companies FRONT-LOAD the fees. So that $7,500 would be deducted from the monthly program payment over a 10-18 month period. Let’s say the company collects the $7,500 over 12 months. This results is fee payments of $625 per month. Where’s the money to settle the debts with? A typical client who’s $50k in debt would pay into the program at around $750 to $1,000 per month in order to build up funds for settlements. That leaves only $125 to $375 per month building up toward settlements. At the end of that first year, the $7,500 in fees are fully paid, but the client has only saved $1,500 to $4,500 against $50k of debt. (Actually, it’s worse than that, because the debts will probably inflate to at least $60,000 during that period, due to all the interest, lates fees, and penalties.)

The big problem here is that some of the best deals happen right before charge-off, which is usually in the 6th or 7th month of the program (assuming the client was current or near-current at the start of the program). So this means that some of the best deals cannot be taken, because too much money has gone to fees and not enough toward savings for settlements. In the old days, the fees were on the back end, charged only AFTER successful settlement. We used to negotiate the first settlement, charge a percentage of the savings, and then start building toward the next settlement. This was much better for the consumer, but it’s tough to find a company out there that still charges this way. There are a few still operating with this contingency system, but even those companies charge 4-5% up front, plus monthly fees. So the original advantage of this type of program has been eroded by the steadily increasing fee structure of the industry.

Since the front-loaded fee structure, or variations on it, have become the norm, it makes good sense for a consumer to bypass those fees entirely by taking matters into their own hands. If it were not possible for consumers to negotiate on their own, that would be one thing, and those front-loaded fees would be justified. But the opposite is the case. Creditors routinely settle directly with consumers, and in fact PREFER to deal directly with the consumer without any third-party intervention. Most of the clients whom I’ve coached on how to do their own settlements are shocked at how easy it really is. In fact, in a lot of cases, it happens automatically as the account gets close to chargeoff. So the message here is simple: Save the fees by doing it yourself. You’ll get out of debt faster as a result, because 100% of your money is going toward debt reduction and none of it toward fees.

Picking up where I left off yesterday on the debt elimination scam, I’d like to shift gears a little and lay down a challenge. I sometimes receive calls or emails from people promoting this system. Because I am easy to reach and I’m a well-known debt expert, they seem compelled to convince me of the worth and merit of their system. Often, the people contacting me are ignorant of the nature of the scam. That’s because this program is frequently sold through MLM or network marketing systems, and a lot of the people involved simply don’t know any better. I respond by making a simple request, and any “true believers” in this system who happen to read this article can take this as a challenge. All I ask is for a single verifiable court case where a judge agreed with the “no money lent” argument and ruled in favor of the debtor. It’s really that simple. After asking this question for several years, I’m still waiting. No such case exists, despite false claims to the contrary. The response is usually that the company must protect the clients’ privacy, but they have “hundreds of success stories” and have dismissed “millions of dollars” of debt.

Nonsense! The only way this system could possibly work is if a judge ruled on it in court. And since court cases are public record by definition, privacy cannot be an issue here. The “client” gave up any right to privacy when he or she tried to convince a judge that the 50 grand they owed on their credit cards was really just “funny money.” And yet the con artists cannot provide a single solitary case in support of their outrageous claims. (Note to scammers: Don’t waste my time emailing me with your threats or your legal mumbo-jumbo. I’ve heard it all before. Just send me the civil docket number for a single case where your “client” won in court using this system, and identify the court venue so I can look up the case myself online. Simple enough, right? I won’t hold my breath though.) In fact, the “no money lent” argument has been shot down in court on multiple occasions. When confronted with this embarrassing fact, the scammers simply reply that the courts are part of a “conspiracy” to keep this information from the public!

The absence of any verifiable documentation is the red flag that tells you this scheme simply doesn’t work. But let me take this a step farther. Let’s set aside for a moment the whole question of the legal basis for the “no money lent” argument. Let’s take a huge silly leap for a moment and say that the system is valid from a legal perspective. Well, it’s STILL not going to work for the average consumer! Why? Two reasons. First, it requires a fight in court, and the average consumer wants to go to court over debt-related matters about as much as they want to have multiple root-canals without anesthetic.

Second, nothing gets resolved this way. I’ve worked with thousands of people struggling with serious debt problems. I talk to people in this situation every day. I can’t think of a single instance where the person’s priority was anything other than to GET THE MATTER RESOLVED PERMANENTLY. The techniques used by the debt elimination scammers do not achieve any resolution at all. Even if the debtor successfully gets a creditor to back off from its collection effort, all that will happen is the creditor will sell the account to a debt purchasing company, who will then try to collect all over again. So the whole process will have to be repeated, over and over again as the debt gets sold multiple times down the line. There is no resolution here. Just a bag of useless tricks. Boil it all down and here is what the debt elimination scammers are telling you: Walk away from your debts, don’t pay, and duck and cover. That’s it. It’s a lot of hot air and bogus nonsense, and it only exists because debt-weary consumers are desperate for solutions.

If you have become the victim of a debt elimination scam, I urge you to take action. Demand a refund in writing. Complain to the Better Business Bureau where the company is located (assuming you can even find them), complain to your state Attorney General and the Federal Trade Commission. And then get on the phone with your creditors and explain that you were misled and that you would like to work things out in good faith. It may be necessary for you to formally retract any documentation that the scammers sent to your creditors. Consumers may also feel free to email me for further advice or information on this subject.

Consumers seeking debt assistance are faced with a bewildering assortment of debt companies, services, programs, books, eBooks, and websites. How to tell the scams from the legitimate options? The purpose of this blog post is to help consumers easily spot and steer clear of one particular scam that is growing through network or multi-level marketing schemes.

It goes under different names, such as debt elimination, debt termination, or debt reduction. Such names can certainly apply to legitimate programs as well, and the scammers purposely name their bogus programs with the intention of deceiving consumers and stealing them away from legitimate companies. For the purpose of this post, I’ll refer to it as the debt elimination scam, but be aware that it may be called something different.

So how can you tell this scam from legitimate debt elimination techniques? It’s pretty easy, actually. The scam is based on the bogus “no money lent” argument, where the claim is made that credit card banks cannot loan money legally. Through strange leaps of logic, the scammers claim that credit card banks are actually operating illegally, and so you never really borrowed any money when you used your credit cards! Therefore, you don’t really need to pay anything back. You just have to follow their system and the debts will go away because the banks don’t want this knowledge disclosed to the public!

I realize this may sound ridiculous at first glance, but the con artists are very convincing, and there are dozens of websites promoting this dangerous scam. They refer to publications by the Federal Reserve Board, the Uniform Commercial Code, the Truth in Lending Act, and other public laws to bolster their claims and give an aura of legitimacy to their “program.” I’ve talked with numerous consumers who have been conned out of $2,500, $5,000, even up to $15,000 because they believed the hype that these snake-oil salesmen were peddling. If you’re $30,000, $50,000, or $100,000 deep in credit card debt, it can be very tempting to believe in a magic pill. What if you could pay someone 15% of the debt and make the rest of the debt disappear?

As tempting as the promoters make it sound, the debt elimination techniques they are using simply do not work. About the only thing they accomplish is getting you sued by your creditors. As you might expect, creditors hate this scam, and they come down hard on people trying to use this bogus “no money lent” system. You don’t need to take my word for this. Check out the complaints on ripoffreport.com about Liberty Resources, a debt elimination scam that was shut down in Ohio. Or do some research on New Leaf Associates out of Florida, a scam that was shut down by the Florida Attorney General after consumers were ripped off for millions of dollars. I’ve personally talked to people who were caught up in both of these scams, as well as others who were involved in scams that have not yet been shut down.

More on this scam tomorrow…stay tuned!

This item made the news today: “Late Payments on Credit Cards Showed Strong Decline in Fourth Quarter 2005.” (Source: American Bankers Association’s Consumer Credit Delinquency Bulletin) In the third quarter of 2005, the number of credit card accounts 30 days or more past due stood at 4.74%, while this figure dropped to 4.27% in the fourth quarter.

So why am I predicting that late payment rates will rise in 2006 when Q4 of 2005 shows a decline? Simple. The results from the end of 2005 include the fact that anybody thinking about bankruptcy had already filed before the new rules went into effect on October 17, 2005. So the decline is artificial at best, and hardly the good news that was reported today.

As we move through 2006, my prediction is that the late payment ratio will rise again. The main reason is because the banks are in the process of raising required minimum payments under pressure from the Office of the Comptroller of Currency. This is a well-intentioned attempt by the Fed to help consumers out of the “endless-minimum-payment” debt trap, but the real-world result will be higher default rates. I talk to consumers on a daily basis who are already struggling to maintain the bare-bones minimum payment level. Add just an extra $50-$100 to that minimum payment level, and many consumers will simply not be able to keep up. So I think I’m pretty safe in predicting an increase in the default rate.

As actual results come in later this year, I’ll post the figures here on this blog. The previous record was 4.81% for the second quarter of 2005. I predict that we will set a new default record and top 5.0% for the first time in the third quarter of 2006. Stay tuned …

And, if you’re already feeling the pinch of the higher minimum rates, you should consider the debt settlement strategy as a means of dealing with the problem.

We set a new record for personal bankruptcy filings in 2005, with a total of 2,039,214 consumer filings. That’s a 30% increase over the prior year. Of course, some of the surge has to do with negative publicity surrounding the new bankruptcy law that went into effect in October 2005. Approximately 400,000 of those cases were under Chapter 13, with the rest being Chapter 7 bankruptcies. It will be interesting to see the statistics later in the year, when we will have a better idea of the effect of the new law on the pace of filings, as well as its effect on the ratio of Chapter 7 to Chapter 13.

Lost is all this new data and hoopla over the bankruptcy law is a simple fact: Many of these bankruptcy filings were not necessary. I’m not talking about the usual media disinformation about “deadbeats” taking advantage of the system. That has proved to be a hollow and false excuse for passage of the new law. (See my March 20th post on this subject.) No, I’m talking about the reality that many people are FORCED into bankruptcy when they would truly rather avoid it. Consumers often get pushed headlong into bankruptcy by a combination of (a) predatory practices on the part of banks and financial institutions that profit from consumer indebtedness, and (b) aggressive collection tactics. The Federal Trade Commission logged more than 58,000 complaints last year about collection abuse. Since that is the barest tip of the iceberg (most people just take it and do not complain), is it any wonder that a consumer otherwise motivated to avoid bankruptcy is forced to it by abusive collection techniques? I’m not saying that the collection industry is evil. It provides a necessary function in our economy. Nor do I have anything against people who collect for a living, even though the industry has more than its share of bad apples.

My message here is simple. Bankruptcy can often be avoided by educating consumers about the option of debt settlement, especially the self-help variety, and by teaching them how to deal with collection tactics. I’ll discuss the problems of third-party professional debt settlement in other posts. For now, I want consumers to realize that avoiding a trip to bankruptcy court is simply a matter of (a) getting educated about how the debt collection process works, (b) developing a financial game plan that makes sense for your circumstances, and then (c) getting on the phone with your creditors with the goal of working things out amicably. It’s called taking responsibility and then taking action. It’s as American as apple-pie. It works, and the financial media is irresponsible for not discussing the most viable option of all for debt resolution. So get educated, take charge, and work things out. It really is that simple.