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.