Should I consider a debt settlement program? Dangers of debt counseling Be a savvy consumer of debt counseling or debt management programs. It is an unfortunate truth that not everyone offering to help you get control of your finances has your best interests (as opposed to their own) at heart. Approach debt consolidation loans with skepticism While a loan to consolidate all of your debt into a single obligation is appealing and may have a lower interest rate than credit card interest rates, make sure that you can really repay that amount. Understand clearly the term, interest rate, and fees associated with the loan. It may be that even lowering the interest rate does not make your present debts manageable; it just postpones the day of reckoning. Find out whether the loan will pay off over the life of the loan, or whether you will owe a “balloon” payment at the end. For most borrowers, balloon payments are just an invitation to another loan, and you never get free of this debt! Home equity loans may put your home in jeopardy If you can’t pay your present unsecureddebts, all your creditor can do is sue you and try to collect any judgment it gets. If you can’t pay your home equity loan, you may lose your house in foreclosure. Most states provide an exemption that protects a given amount of equity in your home and puts that equity beyond the reach of your creditors. If you voluntarily pledge that equity to a home equity lender, the exemption no longer protects the pledged portion of your home’s value. Understand the program If you participate in a program where a service negotiates with your creditors or makes payments on your debts for you, understand whether the service promises to lower the total you owe or the interest rate you pay, or just promises to lower the payments you make every month, without significantly changing your obligation. Know what happens if a creditor won’t negotiate The debt settlement model in which you set aside money with a third party who will attempt to negotiate a reduced payoff seldom solves the entire problem. Creditors seldom accommodate such approaches which is why the debt settlement company pays themselves first. In our opinion, the plan is bound to fail. Make sure the program deals with all your debt Some debt counselors confine themselves to dealing with your unsecured commercial creditors, excluding your obligations for non dischargeable child support, unpaid taxes, or the crushing car loan. In effect, they ignore the debts that are most important, while channeling your money to creditors whose claims could be discharged in bankruptcy. Don’t overpay There are several debt management programs with modest cost to you, the client. Approach fee-based services with caution and make sure that the service is worth what it costs. Many debt counseling programs advertising themselves as “non profits” may be fronts for profit making entities more interested in their own pocketbook than yours Chapter 13 is a more reliable alternative. Beware of tax consequences The IRS treats debts that are forgiven or reduced, outside of bankruptcy, as taxable income. That means that if your creditor agrees to settle the debt for 50% of what you owe, the other 50% will be reported to the IRS as income, just as if they had written you a check for that amount! Under some circumstances, you can avoid cancellation of debt income, but it raises a complicating factor when you compromise debts outside of bankruptcy. Conclusion: Make sure that you don’t worsen your situation by enlisting others to help with debt management. While it is comforting to have an ally in your struggle to pay your bills, make sure that their help is really helpful. Remember that Chapter 13 is a repayment plan in which you propose the percentage that you can repay creditors and upon confirmation, the court makes it binding on creditors. Consider this scenario: Crystal has $12,000 in credit card debt, and ABC Debt Settlement Company advertised that they can settle credit card debts for 50 cents on the dollar. We’ve all heard the ads “Do you have more than $10,000 in credit card debts? Banks got their bailout, now it’s time for yours.” When Crystal contacts ABC about the program, ABC advises her to stop paying her debts in order to show the credit card companies whose boss. ABC has her sign a $515 a month electronic funds transfer from her bank account. This money will be put into an account to use to settle with her credit cards, but guess what? ABC has no agreements to settle anything with anyone. But they keep collecting the $515 a month. Crystal starts getting tons of hate mail and calls from collectors but ABC just tells her to sit tight. “Can’t she see how desperate the banks are getting now?” She goes to get an auto loan, and is shocked to hear that her credit is completely trashed. Eventually she gets sued, but ABC says “don’t worry, there is no need to go to court. Once the suing company gets a judgment against you, they’ll be even more desperate to settle with you.” Then her wages get garnished and she finally, after paying $6,180 over a whole year, calls and asks to cancel the program and recover what is in the account. No debt has been settled yet. How much does she get? Let’s see, that’s $6, 180 she has paid, less the $349 set up fee, less a $24.95 a month administrative fee for 24 months, or $598.80, but all charged up front in advance, a $19.95 monthly maintenance fee for each of the 12 months or $239.40, less a $249 termination fee, and we are at $1,436.20 left in the account. However, the company then claims that because Crystal chickened out and did not stick to the program, not ABC’s problem or fault, ABC is still entitled to its agreed-upon 20% fee on the total debt to be settled (which is now $18,000 due to all the late fees, etc.), so that fee is $4,500. Here you go Crystal, here is what you get back….$243.80..after paying $6,180. Far fetched? I wish. Watch This! Legal? If so, why on earth? Bankruptcy may be your best option.