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We have all seen and heard the ads that shout, "Secrets banks don't want you to know," "You have a right to settle your debts for pennies on the dollar" and "President Obama has a stimulus plan provision that allows you to eliminate credit card debt" ... if only you will call the 800 number in the ad.
People ask me if there is any truth to the ads with an air of skepticism that always contains a whiff of hope that there just might be some secret way that debts can be erased, eliminated or at least shrunk. I can't blame them. I still buy the occasional ticket when the Power Ball lottery gets big enough, like $15 million is just too small for me to bother with. Well, after 19 years of working with families who have experienced crushing credit card debt, demoralizing reversals of fortune or sometimes just plain unrestrained spending silliness, I can tell you that there is no magic wand, no silver bullet, no credit fairy.
So what's with the ads? Is there a glimmer of truth in them? As with much of life, the devil is in the details. Here's the skinny. Since Roman times, total debt forgiveness has been a persistent myth. The theory is that creditors would rather get back something than nothing. So, faced with a debtor who won't or can't pay, they will agree to a reduction on what is owed. The reality is that debt collectors are tougher than most of us and would rather chew off a limb than lose money. In today's credit world, what the ads are really talking about 99 percent of the time is debt settlement.
Most debt settlement programs require you to make a monthly deposit into a bank or trust account. Once the money gets to a sufficient size, usually 50 percent or 60 percent of the debt owed, the settlement company will contact the lender and offer a lump sum to settle the account.
Here's where the devil comes in. The debt settlement companies charge a fat fee that comes out of your deposits. Usually it is taken from your first deposits before any actual settlement occurs. In the meantime, while you are waiting for the account to get large enough for settlement consideration, the collectors are hammering you. First come the letters, then the calls, then the legal letters and summons. (Yes, you can have your wages garnished while you are depositing money into your settlement account.) Typically, a collector would only consider an offer to settle on an account that is at least six months past due. That's a minimum of six months of collections that you will have to endure and often either the lender won't settle or you give in to the pressure and pay. The debt settlement company gets to keep their fee regardless of results.
My experience also tells me that most people are very concerned about their credit score or rating. Here's what a debt settlement process may do to it. First, you have the lender reporting the debt as delinquent. Next, the debt would charge off. If you are sued, there would be a negative public record entry on your credit report. At each stage your score would drop more and the amount you owe would increase from fees, interest, penalties and legal expenses. How much fun is this? For you, none; for some collectors, much; and for the debt settlement company, fun is not the issue, fees are. In the statistically unlikely event that you have a creditor who will settle a debt, your credit report will show an unpaid charge-off and a settlement. Both items are significant negatives for your credit score.
But, as the late Billy Mays used to say, "Wait, there's more!" The amount of debt that is forgiven is not forgotten. IRS rules state that if more than $600 is knocked off your bill (you'd be fiscally insane to go through all this for less), a 1099 is issued and you have to recognize the settled portion of the debt as income ... and pay taxes on it!
The Federal Trade Commission is currently investigating the debt settlement industry and is expected to come down hard on current industry practices. In the meantime, if you really want to try your luck at debt settlement, I suggest you see a reputable attorney. They can offer you sound ethical advice, hands-on help dealing with the collectors and shield you from collection calls. They may even be able to help keep your credit more or less intact during the process by careful and concerned negotiation. Of course, this help never comes cheap. But neither does the alternative.