Q&A: Letting car be repossessed will make debt problem worse

Dear Liz: I own a car that I can no longer afford. Unfortunately, buying it was a poor decision and came with terrible interest rates and terms. I’ve been 30 to 60 days late on the payments for close to a year and have other debts that I haven’t been able to pay. Because of this, my credit is already in the basement. I’m underwater on the car (by about $7,000) and am feeling like the only option is to have it “voluntarily” repossessed. I really feel that if I didn’t have this $400 payment and another $200 a month in car-related costs, I could get my other debts squashed, build some savings and get in a much better place financially. I should mention that I have another (free!) car available to me when I need it and live in an area with reliable public transit, plus I have carpooling options that can get me to and from work at little to no cost. I have no major plans for anything that would require amazing credit scores. I have a stable job and rent an apartment with my boyfriend, who has strong credit but not a huge capacity to help financially. Am I insane? How would I even begin to recover from a repossession?

Answer: Having your car repossessed won’t relieve you of the debt. In fact, your debt is likely to increase.

Repossession costs such as storage, preparation for sale and attorney fees can be added to your loan balance. You’ll owe the difference between that amount and the price the creditor gets for the vehicle when it’s resold, often at auction.

If you don’t pay what you owe, your creditor can sue you — and probably will, given that nice steady job with reliable wages that can be garnished.

So yes, you probably would be insane to think repossession is the answer to your situation.

Usually the best solution when you owe more than a car is worth is to “drive out of the loan” — in other words, to own the car at least until the loan is paid off. In your case, the best solution may be to park the car while you pay it off. A parked car doesn’t need much gas or maintenance (as long as you start it occasionally). You may be able to get discounts on insurance and registration if you don’t operate it.

If you still can’t make ends meet, then get a second job that will bring in some extra cash. Pay off the loan as quickly as possible and then start saving to pay cash for your next car. Also work on repairing your credit so that if you want loans in the future you’ll be able to get decent rates and terms.

Q&A: Understating financial situation

Dear Liz: When applying for credit or at other times when one must state gross income, how should virtual income be computed and treated? My wife and I have annual tax-free income of about $96,000, not subject to offset of any kind, plus our $8,000 annual property taxes are waived in their entirety, as are our vehicle license fees and many other smaller fees. We have free health insurance through the military and the Department of Veterans Affairs that far exceeds the best plan out there. To state our household income as the money that goes into our bank accounts annually is a serious understatement of our financial position. We do not want to lie on a credit application, but we feel we are not being totally honest no matter how we answer questions asking for gross income.

Answer: Creditors are far more worried about people inflating their incomes than they are about people who understate their financial situations. In short: Don’t worry about it.

Q&A: How to deal with debt collectors

Dear Liz: After struggling financially for seven years, I’m getting a good lawsuit settlement. After taxes, I’ll be set. I want to pay my bills but to the actual company — for example, the credit card company, not some bill-collecting clowns that threatened me with “the sheriff will come over and arrest you” or “your brother and sister will inherit your debt” and other lies.

I also don’t want to pay these inflated fees from bill collectors that have no rhyme or reason and sound like they are throwing darts at numbers board.

Finally, I’ve asked a couple of the bill collectors to provide me with the name and contact at the original company so I can verify that they have authorization. But with data being compromised every day, how do I know they are legit?’

Answer: You typically don’t have the option to pay the original creditor once a debt collector enters the scene. Chances are good the original creditor long ago wrote off the debt as a loss and sold it, often for pennies on the dollar. You’ll know the bill is in the hands of a debt buyer if you check your credit reports and the original creditor shows the amount owed as zero, said Michael Bovee, president of Consumer Recovery Network, a debt relief company.

You’re right to be concerned about paying the right party — not because of database breaches but because of the lousy records and bad practices that plague the debt collection industry. The same debt may be sold to multiple buyers or come with so little identifying information that it’s unclear who originally owed what to whom.

Before you pay any debt, you should ask in writing for it to be verified. By law, debt collectors must provide you with the name of the creditor, the amount owed and how you can dispute the debt or seek further verification. The Consumer Financial Protection Bureau offers sample letters on its site, www.consumerfinance.gov.

The CFPB also accepts and investigates complaints about collection agencies, such as those who violate the federal Fair Debt Collection Practices Act by harassing people or falsely threatening to arrest them (you typically can’t be arrested for debt).

It’s understandable that you don’t want to deal with a rogue collector or an unethical collection agency. If the debt is beyond your state’s statute of limitations and you can’t be sued over it, then there’s little reason to open negotiations with such bad actors. They could renege on any deal they make with you and simply sell the debt to someone else, starting the whole circus over again.

If you must resolve the debt — you typically can’t get a home loan, for example, if you have open collection accounts showing on your credit reports — then you should call the original creditor and verify which company bought the debt. If the debt wasn’t sold but assigned to a collection agency, get the name of that firm. Then you can call and negotiate payoffs low enough to offset any fees or interest that have accumulated, Bovee said. But do so before you apply for the loan and don’t let the collectors know you need to clean up your credit, since that weakens your bargaining position.

You’ll want to arm yourself with as much knowledge as possible before you contact any collection agency. You can download a free e-book at DebtCollectionAnswers.com, a site run by consumer advocate Gerri Detweiler, that can help you get started.

Q&A: Helping a friend build credit

Dear Liz: I am selling my car to an old friend with no credit history. (The used car salesman wanted to charge her 6.5% interest.) Is there a way that I can report her timely payments to the credit reporting services to help her build her credit?

Answer: It’s not really practical for individuals to report payments, since subscribing to credit bureaus is expensive.

The rate your friend was quoted actually isn’t bad given her lack of credit history. If she kept the loan term relatively short (four years or less), she might be able to build up enough equity and credit history to refinance it to a lower rate in a year or two.

If she’d prefer not to take that route, you might suggest she explore credit builder loans. These loans, offered by credit unions, banks and some online lenders, are designed to help establish credit histories at the bureaus. The lenders typically put the borrowers monthly payments, minus a small interest charge, into a certificate of deposit that is the borrowers to keep after the final payment.

Secured credit cards are another good way to build credit scores. Borrowers make a refundable deposit with the issuing bank and get a credit line that’s typical equal to that deposit.

Q&A: The hazards of debt settlement

Dear Liz: My wife and I owe about $46,000 in credit card debt. We are considering a debt consolidation plan in which our debt would be reduced to about $27,000. According to what I’ve read and what’s included in the paperwork, any reduction in our debt may be reported to the IRS as income. I’m assuming this would not only increase our tax burden but could result in the forfeiture of some of my Social Security benefits. Am I correct in these assumptions?

Answer: What you’re considering is debt settlement, not debt consolidation.

With debt consolidation, you get one loan to pay off other, smaller debts in full. The right debt consolidation loan would offer a fixed interest rate and would allow you to pay off what you owe within three to five years.

Debt settlement, on the other hand, means you’re trying to get your creditors to accept less than what you owe. Debt settlement typically requires that you stop making payments to your creditors, which will trash your credit scores and could lead to lawsuits. You typically accrue interest, late fees and penalties that could offset or even wipe out any savings the debt-settlement company is promising you.

And the fact that the company seems to be promising you specific results, such as a $19,000 reduction in your debt, is a red flag all on its own. Your creditors don’t have any obligation to settle with you, and a debt settlement company shouldn’t promise that it can make the debt disappear.

To answer your specific questions: Yes, any debt that is “forgiven” in a settlement is considered income that can be taxed. It isn’t considered earned income, however, and so doesn’t trigger the Social Security earnings test that can reduce your benefits.

You’d be wise to read what the Federal Trade Commission and the Consumer Financial Protection Bureau have to say about debt settlement on their sites. In the vast majority of cases, you’re better off avoiding this option. Pay off what you owe if you can. If you can’t, explore a debt management plan offered by a nonprofit credit counselor and also make an appointment with a bankruptcy attorney so you understand all your options.

Q&A: Cashing out an IRA to pay off credit card debt

Dear Liz: I owe about $49,000 on my credit cards and now have the money to pay them off in full. Should I? Or should I slowly pay them in large amounts?

Answer:
There’s typically no reason to delay paying off credit card debt. Carrying balances costs you money and doesn’t help your credit scores. You’ll see the fastest improvement if you pay them off in one fell swoop.

The only excuse for delaying would be if this windfall comes from a retirement fund. Cashing out a 401(k) account or IRA to pay off debt is not wise, since you’ll trigger huge taxes and penalties. Add in the future tax-deferred compounding you lose and the total cost is far more than you’ll save in interest.

Q&A: Taking out a loan to boost credit scores

Dear Liz: I have little to no information — good or bad — in my credit reports. I am considering obtaining a secured loan from my credit union to establish better credit. Does it make any difference to my credit score if the credit union reports the loan as “secured”?

Answer: Credit scores don’t treat installment loans differently based on whether they’re unsecured, with just your promise to repay, or secured, which means backed by an asset such as an amount on deposit with the credit union.

What matters is how you pay off the loan (every payment should be on time) and whether the account will be reported to all three credit bureaus, so that you’re building scores at all three. Call and ask, because not all credit unions report to all three bureaus.

You also might want to consider a secured credit card, because having both types of credit accounts — installment and revolving — can boost your scores. Again, it’s important that you pay on time and that the card is reported to all three bureaus. You should use the card lightly but regularly and pay the balance in full each month for best results.

Q&A: Getting rid of robocalls

Dear Liz: We’re getting daily robocalls from collection agencies attempting to collect debts from people with names similar to our own. Generally we ignore the calls on the advice of a friend whose mother died heavily in debt and who said nothing can be gained from a conversation with Repo Man. Is that good advice?

Answer: Ignoring debt collectors isn’t always the best advice — but in this case, it is. Using autodialers and pre-recorded messages is a hallmark of scammers hoping to scare people into paying debts that aren’t theirs.

If you’re not already signed up with the federal Do Not Call Registry at www.donotcall.gov, then do so. If you are on the list, file a complaint at that site. You also can make a complaint at the Consumer Financial Protection Bureau at www.consumerfinance.gov/complaint.

Another good option is signing up for a free service such as NoMoRobo, which detects many scam calls at the first ring and hangs up on them.

Q&A: How to pay down debt

Dear Liz: I am wondering about what to do with some debts I have due to divorce. I make about $50,000 a year and owe $50,000 in credit card debt, attorney’s fees and back property taxes. The good thing is that I own a house free and clear that is worth about $2.5 million. The bad thing is that my credit score is terrible, about 450. Should I slowly try to pay down my debt? Is there anyone who would lend me the money with a home equity line of credit or something similar? I have two children in college who need money from me as well.

Answer: Paying down what you owe over time could be difficult given the size of your debt relative to your income. Often when consumer debts equal or exceed a person’s annual pay, it’s time to consult a bankruptcy attorney. That may not be a good option for you, though, because a bankruptcy court might require you to sell your house to satisfy creditors. Only a handful of states, including Florida and Texas, protect the entire value of a home in bankruptcy.

You could try to get a home equity line of credit, but you’ll probably have a tough time finding a lender. If you succeed, you would face high interest rates.

Selling the house and downsizing could help you settle your debts and free up money for your children’s educations. That’s a big move, though, and could have tax as well as financial aid implications.

Your debt shouldn’t be your only concern. You also need to think about how you’ll pay for retirement and other future costs, such as medical expenses and long-term care.

You need some help making these decisions. A fee-only planner could look at your entire financial situation and offer advice, as well as referrals to tax and bankruptcy experts who could offer their assessments of your options.

Q&A: Co-pays and collections

Dear Liz: My primary care physician referred me to a gynecologist for a medical issue. I called the office three times and asked that the appointment be made as an annual exam.
During the appointment, the doctor was rude and critical of my body and lifestyle. (I am obese.) I left the appointment in tears before it was over.

Five months later, I got a $160 bill for the appointment. My insurance denied the claim twice, saying the doctor was double charging, but the office fought back, saying the charge was for the referral, not the annual exam.

I have tried to work with the doctor’s office and my insurance, but now the bill has gone to collections. It’s knocked my FICO score from 780 to 680 in a matter of months.

Part of me does not want to pay the bill because of the abuse I received from the doctor. However, this is affecting my finances. Would it help my FICO score if I negotiated with the bill collector and then repaid a part of the bill? What are my options?

Answer: Your best option is to ask the doctor’s office, politely, to take back the collection account in exchange for your paying the bill in full.

The doctor should not have been rude to you. But you shouldn’t have tried to get a referral for a medical issue treated as an annual exam. You were probably trying to avoid a co-pay, because health plans typically cover this type of preventive care, but that’s not why you were there.

You could ask whether the bill collector will delete the account from your credit reports. You would almost certainly have to pay the bill in full to win this concession, and even then the odds are against it.

That’s why it’s better to ask the medical provider to take back the account. In many cases, medical providers place accounts with collectors on assignment and have the ability to pull them back if they want.

The latest version of the FICO credit scoring formula ignores paid collections and treats unpaid medical collections less harshly than other collections. But that formula is just starting to be adopted, and the more commonly used previous version, FICO 8, ignores only collections worth less than $100.

As you’ve seen, even one dispute can lead to a big drop in your scores. If you feel an issue is worth pursuing, it often makes sense to pay the disputed bill and then seek justice in Small Claims court.