One of the biggest concerns for Americans who are struggling with debt, and looking for solutions to get out of debt, is their credit score. The question that I’ve heard most frequently over the years of working and consulting with consumers is; what will “this” do to my credit report? My answers are generally pretty enlightening, and because there are so many misconceptions, and even people willing to mislead consumers in order to sell them on some approach, I want to lay out some facts.
Let’s start with this fact: Risk aversion by lenders, in the extension of credit, has returned with a vengeance! This means that if your Debt to Income (DTI) is unhealthy, you will frequently find that additional credit is unavailable to you regardless of your credit score. Many consumers are finding that existing credit lines are being cut down to current balances and unused accounts are being closed. There is much more to discuss on this topic, but for the consumer struggling with debt my point is; stop thinking about your score. Additional credit availability is unlikely right now, anyway.
The credit score has been so indoctrinated into our consumer based society; people make irrational decisions, negatively impacting themselves and their families, all in the name of the all mighty FICO. So, as if through a megaphone from 10 stories below; “Put down that credit report and step away from the ledge”!
If you’re struggling with debt, whatever the hardship, and are forced to consider your options. I will lay out the legitimate options and outline the effects to your credit.
Debt Management Plan(DMP, sponsored by for profit or nonprofit credit counseling companies): Your accounts that are accepted into the program will be closed and this will have a slight impact on your score. While enrolled in the program, it is typically very tough to get financing of virtually any nature in the first 24 months, due to the DMP notation in your credit report, next to each of the accounts enrolled. Debt Management Programs run, on average, 5 years. You are basically in “unsecured credit purgatory” for this entire period (such as obtaining new credit cards). You may be able to get financing on a vehicle or even purchase a home, modify an existing home loan, or qualify for a student loan (either your own or parental) after the first 2-3 years of successful participation in your DMP. When an account in your DMP is fully paid, the DMP notation is removed. This is a good option, if the math supports your finances (more on the math in a moment).
File Bankruptcy: Chapter 7 – will stay on your credit report for 10 years. This does not mean you won’t have access to credit for the full 10 years! This is one of the biggest misconceptions out there, and partially what motivated me to write this. There are many reasons to try to avoid bankruptcy. Your ability to get credit in the future is one of the flimsiest. Up until the economy started crashing in 2007, consumers who discharged debt in a chapter 7 were finding unsolicited credit offers in their mailbox within 6-12 months of discharge. The credit offers were generally subprime, so not the best limits and rates, but were offered nonetheless. With the return of risk aversion, and many of the subprime credit card issuers having left the market, I don’t see these solicitations for credit just outside of bankruptcy being offered much, at the time of this writing. I find them even less likely moving forward, as banks will be repairing their balance sheets for years to come. Besides, having just obtained discharge of unsecured debt, one should not be in a hurry to obtain more, and most certainly not at subprime rates.
Current FHA underwriting standards mean you will not qualify for FHA funding after filing bankruptcy for a period a 2 years. It is, therefore, unlikely you will get a loan for a home purchase in this time frame, in the current loan market. Student loans are generally off the table for a few years, including ones you would apply for in order to assist your child. You may be able to finance a vehicle purchase after a chapter 7 within 12 or so months after discharge.
Your credit score is factored on several data points. 35% of it is reportedly factored on utilization/Debt to income (DTI). After discharging debt in a chapter 7, your DTI and utilization should be fabulous. Now, you wait out some of the 2-3 year timelines lenders and underwriters use as a standard, take a few effective steps to rebuild credit, and this whole 10 year misconception is seen for the baloney it is.
Chapter 13 – is totally different. It’s the worst of all options. The court is overseeing a repayment plan of 3 or 5 years. It’s on your credit report, you’re on a court approved household budget, and if you were to seek a new credit contract of virtually any type, you must first get approval from the court appointed trustee, who has been empowered to tell you “NO”. This version of bankruptcy is credit purgatory. It is rigid and inflexible. You will have court protection from creditors, but at the highest cost. It is an option, but should be seen as a last resort.
Debt Settlement: Settling debts for less than the balance requires you to be behind in payments. Since another 35% of your credit score is factored on repayment history, your credit report and score is going to get clobbered! The clobbering itself and the duration of the pain will be different for each person. Once you achieve zero balance reporting, your credit score will begin to improve. How long it will take to improve will depend on several factors, such as:
How long you went delinquent before a zero balance was reported
Was the account charged off (settling debt inside of 6 months delinquency is optimal)
Was it sold after charge off and re-reported (original creditor reports the charge off and the debt collector reports as well)
What accounts were current during the settlement process (mortgage, car payment, other)
What was the depth of your positive credit history (have you had cars, mortgages etc… paid off in the past)
Did you take prudent steps to rebuild credit along the way
My experience has shown that roughly 18 months after completing the last settlement, and the zero balance due reporting, you’re in decent credit shape again, when contemplating legitimate needs. I have seen CRN members qualify for FHA funding on a new home purchase 9 months after finishing their settlements (focusing on the above 6 items) . The primary reason for this is that your debt to income is in better shape, and the math shows you can comfortably service the mortgage. This aspect should be considered by those who have been turned down for a modification on an existing home loan based on their DTI, and who have resources that can be creatively deployed.
Summary: These 3 options are what a consumer, who cannot keep up with payments, has to consider. The fact is; every one of them is going to hurt your score. Even just slogging along and struggling to meet your minimums is going to keep you from any new credit, based on a poor DTI ratio, regardless of the FICO score. The days of fog a mirror – and get credit – are gone.
Basing your decision on which option to go with because of the affect on your credit report, is like arguing over whether to punch a one foot or two foot hole in the bottom of the boat while at sea. The boat sinks no matter what.
These 3 options actually track pretty well when you boil them down to which one will put you in position to obtain legitimate loans, like a home/car purchase or student loans, the quickest.
The point is, when you are drowning in debt and are worried about your credit score, you’re worried about the wrong thing.
The media, lenders, regulators, unwitting commentators, have all contributed to the credit score hype. Sure, it is important when you are out shopping for loans and better interest rates, but that’s not what someone who cannot keep their payments up should be thinking about. They are not going to get credit, and they cannot service the additional debt anyway. Anyone saying something different is talking up their book, has the luxury of not struggling with debt, or is a pump monkey for some special interest.
When determining which debt relief option will best suit your situation, and you’re mid-to-long term goals, always start with the math. The math doesn’t lie and should assist you in narrowing down which option is best.
Chapter 7, for those who qualify, and who fully understand all of the implications associated with filing (sans the credit score), will provide the quickest, most thorough relief.
Other than a discharge through bankruptcy, my experience would suggest that consumers weigh and compare a debt management plan (DMP) beside a debt settlement approach, and make a rational decision based on the math and the flexibility that is built into either option. Settlement will generally win this test. When doing the math to qualify for a DMP, you will need to factor your ability to consistently and comfortably make a monthly payment of 2.5% of your current unsecured credit card balances. If you cannot, or question your ability to maintain this type of payment, I question why you would even start a DMP. You have a high probability of not completing it and will have wasted resources that would have contributed to your success using a settlement approach and the ability to regain your financial freedom sooner.
If you have hit the debt wall and want to learn about all of your debt management options, including debt settlement, visit Consumer Recovery Network. While you’re there, learn about becoming a member of Consumer Recovery Network, with no risk to you, and schedule a consult to find out if you should pursue debt negotiation.
Here is the link of a company that solicited Consumer Recovery Network to buy live transfer leads from them last month (These come in virtually every day):
ineedyourleads.com
Commercials like this are aired on television; the consumer calls the number and is asked perhaps 3-4 qualifying questions and re-routed to a call center or settlement firm with their own internal sales floor. Perhaps the number provided will go direct to a sales floor without a pit stop for a 4 question qualifier.
This type of advertising, at its peak last year (perhaps some will pay this even today) ran anywhere from $75.00 to over $100.00 per live transfer. A good (meaning productive–not necessarily ethical) call center in this industry, paying for, and working these leads, has a cost per acquisition (CPA) of anywhere between $600.00 to $1200.00. They have to run a 20% close ratio or higher, in most cases, to hit their numbers. That means they have to approach what they do as a sales process rather than a consultation process.
The majority of people sold into settlement, in my opinion, don’t belong in it. Either the process was sold as butterflies and rainbows, or the plan, due to high upfront fees, which are often successfully disguised to the average consumer stressed to the gills and looking for relief, provides for high incompletion and program drop rates. The higher the fee, no matter how it is calculated or paid, is one of the bigger stumbling blocks to being successful in working with a settlement company. The fee itself can prevent the consumer’s success. Fees average 15% of the total debt that is submitted for settlement. Why so high? Often enough, the fee amount is related to the juice, but I am getting ahead of myself.
The only ethical way to promote settlement as an option is from a consultation/informative perspective where there is no pressure to hit a quota due to high CPA. If a company does any national advertising or purchases live transfers from a national advertiser whether radio or television, it is nearly 100% assured that they are using a sales approach. They must closely monitor closing ratios of the phone staff, and cut anyone occupying a chair who doesn’t hit the numbers. I have visited a few call centers. The majority of men and women in these call center atmospheres are best defined as telemarketers. There are, I am sure, exceptions. In fact, I have met some. That is not the norm though. These are the same people who will be just as effective at telemarketing residential home siding, as settlement services.
The juice:
Your future… sold to the highest paying servicer! On first contact, if you are not talking to the company that is actually going to handle your file, you are talking to a sales guy. His motivation is selling you into settlement, whether or not it’s a good fit for your situation, in order to get a commission. The criteria for where the sales guy will refer you, in my opinion and industry experience, will not be based on who does the best work, who has the most success with consumers, who will best serve your actual needs for getting out of debt with a settlement process, or who is going to charge the least so that your money actually goes to your creditors. It is absolutely (and unfortunately) predictable that the vast majority of those selling settlement, will gravitate to referring you to where they will get paid the most. You will seldom be referred to a servicer whose fees do not maximize the commission sought by the sales person or the company they work for.
The investment required to run one of these centers requires their owners to search out the companies that pay the highest commission for the referral. I have both seen and heard reference to as much as 70% – 80%, payouts of client fees for referrals. Ridiculous? Absolutely! This model is unsustainable for any long period of time. The marketing firm will just move onto the next back end servicer who provides the highest commission. I have witnessed it. Hess Kennedy gets shut down, the sales center then refers to Allegro. Allegro is now shut down, so they will move onto the next. If you’re reading this and are wondering if you are a victim of the “gist & the juice”, the fact that you’re wondering means you probably are.
The price for all of this is passed onto the consumer. They are the ones paying for it through their wallet/purse, and also in the form of lost time and opportunity for the fact that settlement was never the right option for many of them in the first place. They were sold into it.
The lies:
One of several fabrications, or shall I say “massaged facts” used by the settlement sales person is a manageable monthly payment into your settlement fund, thereby extending program length. This is huge, and is used repeatedly because of its success. For example: You have $30,000 in unsecured credit card debt and are paying interest rates somewhere in the 20% range. Your struggling to meet minimums and are looking for options and respond to an ad to “settle for pennies on dollar” or “Get your piece of the bailout and settle with your creditors”. The sales pitch is to put you into a settlement program where you will not be paying your creditors and saving $416.00 dollars a month for 36 months. This is half your current debt. Well Shazaam! That sounds like the kind of relief you are looking for! Your monthly minimum payments, at the high interest you are stuck at, equaled a thousand plus, and this nice man or woman is saying you can be out of debt for the low-low price of $416.00 a month. This is e-a-s-y to sell. This type of relief being offered is what many of us would focus on, no matter how much more there is to the pitch. It’s human nature. It’s the relief we need, and we found it. Some will outline a 42 month plan, or even longer. E-A-S-Y.
Here is the problem. The longer it takes to settle with your creditors, the higher the risk one or more of your creditors will sue you in court in order to collect the debt. Where is your sales guy when this happens? Did he mention you could be sued? Maybe in passing, and if so, he probably said it is very rare to have that happen. What you were not told is that the longer your program lasts the more risk you face of being sued. That would take away all of the relief you felt from having been paying over $1000 a month, to now saving less than half of that a month for settlement. That little massaging of facts goes a long way for the sales close ratio.
The truth about settlement is; you have to be aggressive. You have to put every available penny aside to settle the debt as fast as possible in order to avoid something as adverse as a lawsuit. The relief you will find by using a settlement approach is not going to come until the debt is gone. Settlement is the “rip the band aid off” approach, rather than picking at the corners.
How big is your risk of being sued along the way? It will be different for everyone. It can depend on how fast you can settle, who your creditors are, who they may assign the debt to, who a creditor sells your debt to, what your credit report looks like, the state you live in, transaction history on the account leading up to default. Is a debt settlement sales person going to go over all of that with you?
Lawsuits filed, in order to collect on unsecured credit card accounts, are generally a pretty low percentage compared to how many accounts default each year. I believe those numbers will start to increase in what’s left of 2009 and into 2010. The two largest card issuers in the U.S. have been huge participants in submitting defaulted accounts for arbitration, an alternative dispute resolution done outside of the courts. The National Arbitration Forum (NAF) and the American Arbitration Association (AAA) have ceased all arbitration activity relating to consumer credit cards this summer. Card issuers will likely increase the accounts they place with collection law firms as a result.
At Consumer Recovery Network, we do NO paid advertising. We do not have sales people. When you consult with CRN, you are talking to a specialist on first contact, someone who works with our members and their creditors every day.
If you have hit the debt wall and want to learn about all of your debt management options, including debt settlement, visit Consumer Recovery Network. While you’re there, learn about becoming a member of Consumer Recovery Network, with no risk to you, and schedule a consult to find out if you should pursue debt negotiation.
Settlement with creditors is a great way to deal with debt when you are unable to maintain consistent payments. It is however, not a cake walk, though many in my industry will sell it as such.
This post was inspired by a consult I did this morning with a gentleman in Pennsylvania looking at settlement as an approach to dealing with his unmanageable debt. He wondered onto our website while searching out his options, after having already consulted with another company in the industry.
His unsecured debt totaled $22,000, spread out over 7 accounts. His minimum payments are just over $900.00 a month. His interest rates on most of the accounts are over 20%. That is what’s killing him. He would be able to meet minimums, but for the higher interest, and likely be very successful using an aggressive debt rollup, or debt snowball strategy, to get out of debt quickly and unscathed. His plight, when outlined to creditors, has thus far resulted in “Dude meets wall”.
The company he consulted with prior to me outlined a 36 month program where he could pay into an account roughly 300.00 for 36 months and poof, his debt is gone. Never mind that $3300 of that money set aside over that time will go to the settlement companies fees, I’ll get to that in a moment. The sales person with whom he consulted is selling rainbows and unicorns for a commission. The 36 month plan for his situation is ridiculous for some of the following reasons.
Two of the accounts we discussed have balances of about $1000.00 and another one for $1500.00. Enrolling these accounts in a plan like this, unless they are the first ones settled (even then not advisable, unless left with no choice) is futile and silly. The math doesn’t work. Optimum balance reduction through settlement only happens when you are delinquent, often very delinquent (5 months or more). When you stop paying, default interest rates of 29-32% will be applied, late payments will be assessed, all of which could result, in some cases, in over limit fees being tacked on. Depending on when settlement is reached the amount of the debt could now be double. Can the debt be settled? Absolutely, but using 50% savings as an example, what did you actually save? Nothing, or close enough to nothing to prove that the math doesn’t work.
What if we take these 3 smaller accounts out of the equation? We are now working on $18,000. By aggressively saving and setting aside every penny, this family could be out of debt in less than 12 months and limit to near nonexistent, the risk of being sued on unpaid debt.
Now, I was completely upfront with this consumer about the way I saw his situation and perhaps he appreciates the candor and becomes a member. Perhaps the other consult he had sounded more appealing, with its 36 months, low (too low) payment to his savings for settlement and easier sounding approach. He will pay the typical fee in this industry, which by their very nature is harmful to the settlement process. The sales person will make his commission (some cases I have seen, commissions are in excess of 70% of client fee) for selling rainbows and unicorns.
He may ultimately be out of debt in 36 months, but it will have been a very long 36 months, and he will have paid too much, experienced too much grief, may be sued on one or more accounts and may miss out on strategies that could have been beneficial to recover his credit standing much faster (this is whole different topic for another post).
Moral to this post: Don’t buy into rainbows and unicorns unless you are into paying a salesman’s bills when you can’t afford your own. The settlement industries frontline is, for the most part, populated by sales people motivated by commissions. Rarely do you find a place where you can consult with, and talk to an experienced debt specialist on first contact, prior to forking over any fees and whose motivation is your success, not your money.
If you have hit the debt wall and want to learn about all of your debt management options, including debt settlement, visit Consumer Recovery Network. While you’re there, learn about becoming a member of Consumer Recovery Network (CRN), with no risk to you, and find out if you should pursue debt negotiation.
In a recent blog post written by Diane Stafford with the Kansas City Star entitled: Bankruptcy filing thwarts re-employment, Stafford highlights a key reason why consumers who can qualify for a Chapter 7 liquidation of debt bankruptcy should research ways to avoid it, if at all possible.
One of the primary benefits of filing for Chapter 7 bankruptcy is that your unsecured debt, like credit card debt, gets discharged or wiped out, which gives you the financial fresh start you need if you are strapped with too much debt. However, as Stafford points out, not only will your bankruptcy be part of the public record and noted in your credit report for 10 years, but in today’s job market having that information in your credit file can make it much more difficult to find a well-paying job. That’s because there is a lot more competition for good jobs and so many employers are using other criteria besides an applicant’s resume and references to help them decide who is the “best” person for the position they want to fill. In many instances, one of those criteria is whether an applicant has filed for bankruptcy. The theory is that if an applicant can’t manage her own money, then she probably has bad judgment and would not make a good employee. Of course, as Stafford points out, this attitude does not take into account why an applicant filed for bankruptcy. For example, the applicant may have an ex-spouse who is not paying her the child support she is legally entitled to or the applicant’s health insurer is refusing to pay many of the medical bills associated with his wife’s serious illness.
Therefore, professionals who have been downsized or are concerned that they may lose their jobs should recognize how easy it is to hit the debt wall when they are out of work and should take aggressive steps to address their debt. Although filing for bankruptcy is an option to consider, they should also consider other alternatives, like debt negotiation. Debt negotiation has proven to be an effective option for credit relief and can prevent a bankruptcy from appearing on your credit report.
Debt negotiation involves contacting your creditors, such as the banks that issued you credit cards, to try to reach a compromise with them regarding how much money you’ll have to pay to pay off your accounts. Your goal during your negotiations is to get each of your creditors to agree to take less than the outstanding balance that you owe and for the amounts that that they agree to accept to be amounts you can afford. These negotiations are typically predicated on your having missed several consecutive payments on your accounts and on your ability to establish that a hardship — like a job loss — has made it impossible for you to pay your outstanding balances.
Until recently, large creditors, especially banks that issue credit cards, have had long-standing policies regarding when they will offer a settlement to a consumer and when they will consider a settlement that a consumer offers to them. Now however, given the current state of our economy, the troubles within the banking sector, the financial industry’s new focus on risk aversion, and increases in account charge off percentages, many banks have not only become more willing to settle credit card debts, but they are also willing to settle for less money than they would have agreed to in the past. This is good news for debt stressed consumers.
In her blog, Stafford mentions the plight of one professional who might have been able to avoid bankruptcy if he had pursued debt settlement after he lost his job. She writes: “I heard from a professional who lost his job in a March 2008 downsizing at Sprint and began a so-far fruitless job search. His severance ran out, he and his wife depleted three 401(k) savings accounts and used up other savings. They pinched all the pennies they could and are trying to keep their home through a Fannie Mae Loan Modification program.”
The plight of that individual sounds very similar to stories I hear all too often. After losing a job, or experiencing a cut in pay, consumers are optimistic that things will work out for them and so while they are looking for work, they use up their savings and draw down the money in their 401(k)s so they can pay their living expenses and their debts. However, once their money runs out and they are still jobless, many of these consumers end up in bankruptcy. Although I am not criticizing the optimism of these consumers — they need it to help them get through the tough times ahead — I am suggesting that many of them might have made better use of the money in their savings and retirement accounts by using it to settle with their creditors. That way they could have avoided bankruptcy and possibly made it easier to find new well-paying jobs.
Although there always has been and always will be consumers who will benefit more from a Chapter 7 than from negotiating their debts, the fact is that many debt-stressed consumers who do file were actually excellent candidates for debt settlement.
If you have hit the debt wall and want to learn about all of your debt management options, including debt settlement, visit Consumer Recovery Network. While you’re there, become a member of Consumer Recovery Network (CRN), with no risk to you, and find out if you should pursue debt negotiation.
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