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?

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.

Q&A: Paying off student loans vs saving for retirement

Dear Liz: I’m engaged to be married and need your advice on getting started in the world of shared finances.

My fiance is 43, I’m 31. He’s debt free, with a savings account but no retirement fund. I have $34,000 in student loans (consolidated at 4.25%) and it weighs heavily on my mind as I’m desperate to become debt free. I’m debt free otherwise with $10,000 in savings.

We both make good money but my income as a freelancer is sporadic, while his is steady with periodic bursts of additional income.

We want to be debt free as a couple, save up a solid emergency fund and start making up for lost time on retirement savings, all while being aware that a family and a house might not be far away.

He’s very supportive and wants to pay off my student loans. Should I let him and pay “us” back to the emergency fund or maybe a house down-payment fund? What’s our best course of action to start on a solid financial footing?

Answer: You’re already behind on retirement savings, which should have started with your first job. Your fiance is even farther behind.

Don’t let your zeal to repay your debt blind you to the very real risk that you might not be able to save enough for a comfortable retirement if you don’t get started now.

If your education debt consists of federal student loans, then your low rate is fixed. The interest probably is tax deductible, which means the effective rate you’re paying is just a little over the inflation rate. It isn’t quite free money, but it’s pretty cheap.

You don’t need to be in a rush to pay it off, particularly with all your other financial priorities looming.

Instead, get going on some retirement accounts. Your fiance should take advantage of his workplace plan, if he has access to one.

Most employer-sponsored workplace plans have company matches, which really is free money you shouldn’t leave on the table. An individual retirement account or Roth IRA can supplement the plan or be a substitute if he doesn’t have access to a workplace plan.

As a freelancer, you have numerous options for setting aside money for retirement, including Simplified Employee Pensions (SEP), Savings Incentive Match for Employees (SIMPLE) and solo 401(k)s that would allow you to contribute more than the standard $5,500 annual limit for an IRA.

Ideally, you would be saving around 15% of your income and your fiance 20% or more.

If you can’t hit those targets just yet, start saving what you can and increase your contributions regularly. Work your other goals around the primary goal of being able to afford a decent retirement.

Q&A: Personal loan debt vs credit card debt

Dear Liz: I need to understand how credit reporting agencies treat personal unsecured loan debt versus credit card debt.

I am considering getting a personal loan from a reputable lender to pay down my credit card debt. The amount of my overall debt will still be the same, just in a different category. How will my credit score be affected?

Answer: What you need to understand is how credit scoring formulas treat installment debt (loans) versus revolving debt (credit cards). Credit reporting agencies maintain the credit reports used to create scores — but don’t bless (or curse) particular types of debt.

The personal loan’s overall effect on your credit scores is likely to be positive if you pay the loan on time. What you owe on an installment loan is typically treated more favorably than a similar balance on a credit card.

Installment loans have other advantages: You typically get a fixed rate, rather than the variable one charged on most credit cards, and your balance will be paid off over the term of the loan, which is usually three years. If you stop carrying balances on your credit cards, you should be in much better shape: free of debt with potentially higher scores.

Often the best place to get installment loans is from credit unions, which are member-owned financial institutions that may offer lower interest rates.

Avoid any lender that gives you a high-pressure sales pitch, that offers you a loan if you have bad credit or that pitches debt settlement, which is far more dangerous to your finances than a personal loan.

If the lender tries to tell you about a new “government program” that wipes out credit card debt or tries to collect big upfront fees, you’ve stumbled onto a scam.