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Get smart with your money

debt settlement

Q&A: The hazards of debt settlement

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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.

Beware debt reduction offers

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Dear Liz: What is your opinion of debt reduction programs? I am constantly receiving mail from various companies, and I was wondering if they are legit. They claim they can reduce my debt, which sounds promising, but I am hesitant to get involved with them.

Answer: You’ve got good instincts.

Many of the companies sending out these solicitations say they can settle your debt for pennies on the dollar. What they often fail to mention is that the debt settlement process can result in your being sued by your creditors and having your credit trashed. That’s assuming they try to settle your debt at all, rather than just disappearing with any money you pay them in advance.

If you’re struggling with too much debt, you should make two appointments: one with a legitimate credit counselor (visit the National Foundation for Credit Counseling at http://www.nfcc.org for referrals) to see whether you qualify for a debt management program to repay your credit card debt, and another with a bankruptcy attorney (check the National Assn. of Consumer Bankruptcy Attorneys at http://www.nacba.org for referrals) to see whether a bankruptcy filing might be appropriate for your situation.

Co-signing card leads to collectors’ calls

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Dear Liz: I co-signed a credit card for someone and the person defaulted on payment. I started making payments but could not continue because I became unemployed. The debt started at $15,631.23 but has gone up to $17,088.08 because of interest and fees. I previously had to go to court because my bank account was frozen. I recently got a notice about this again. Should I file for bankruptcy or try contacting the attorneys who are seeking payment? I am working part-time and have a tight budget. I don’t have anything saved and am living from paycheck to paycheck.

Answer: You should have gone to a bankruptcy attorney the first time you got sued.

Many people try to ignore their debts or hope that collection agencies will be lenient. That’s not a good strategy at a time when collectors are increasingly willing to file lawsuits to get paid, said Gerri Detweiler, director of consumer education for Credit.com. Once collectors have a judgment against you, they can freeze your bank accounts or garnishee your paycheck.

If you don’t have anything saved and can’t come up with any money for payments, you have little leverage in dealing with a collection agency. Bankruptcy may be your only recourse to get these collection efforts to stop.

A bankruptcy attorney can let you know whether you are “judgment proof,” which basically means that you have and make too little for a creditor to collect on any judgments. If you are judgment proof, you may not need to file for bankruptcy, but you may have to deal with frozen accounts and regular trips to court when a collector oversteps.

You can get a referral from the National Assn. of Consumer Bankruptcy Attorneys at http://www.nacba.org.

The only silver lining of this situation is that you’ve provided other people with a clear lesson in why they shouldn’t co-sign a credit card or any other loan for someone else.

Our #CreditChat is about to begin!

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liz-westonIn a few minutes I’ll be answering your questions about how to deal with your debt on Experian’s #CreditChat, which starts at 3 p.m. Eastern/noon Pacific today. Topics include how to balance savings and paying off debt, which debts to tackle first, how to handle student loans and what to do if you’re drowning in debt. Easy ways to follow the conversation include Twubs or tchat.

Please join us!

My book is out! Get it for free.

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DWYD cover2013“Deal with Your Debt” is now available, and I’m giving away five copies this week.

To enter to win, leave a comment here on my blog (not my Facebook page).

Click on the tab above the post that says “comments.” Make sure to include your email address, which won’t show up with your comment, but I’ll be able to see it.

If you haven’t commented before, it may take a little while for your comment to show up since comments are moderated.

The winners will be chosen at random Friday night. Over the weekend, please check your email (including your spam filter). If I don’t hear from a winner by noon Pacific time on Monday, his or her prize will be forfeited and I’ll pick another winner.

Also, check back here often for other giveaways.

The deadline to enter is midnight Pacific time on Friday. So–comment away!

Be careful when settling old debts

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Dear Liz: I paid all of my old collection accounts except for two, which now are beyond the statute of limitations. I would like to find the best way to negotiate with the collection agencies without getting sued. Even though the original delinquency was over four years ago, the agencies are reporting these every month as current debt, which is really hurting my credit score. My intent is to offer a lump-sum settlement amount if they will remove the report from my credit file with the bureaus, or alternately in return for a “paid” notation on my report file. However, I cannot afford to pay the amount they say I owe.

Answer: If the collection agencies are simply reporting your debts each month with a correct “date of last activity” — usually the date you stopped paying the original creditor — your credit scores aren’t being hurt anew each month. If the agencies are reporting a new date of last activity each month, however, they are illegally re-aging your debts. You can dispute this illegal reporting with the credit bureaus and directly with the collection agencies. If the errors aren’t corrected, you can file a complaint with the Consumer Financial Protection Bureau, which took over regulation of the major credit bureaus last year.

Filing disputes is not something you’d want to do if the debts are still within the statute of limitations, said Michael Bovee, president of Consumers Recovery Network, which specializes in debt settlement. You wouldn’t want to draw attention to yourself or your debts. But you run little risk in filing a dispute now since the debts are too old for the collectors to file a legitimate lawsuit.

Bovee said that simply contacting the agencies about the debts shouldn’t restart the statute of limitations, but debt expert Gerri Detweiler of Credit.com advised caution.

“It may be well worth it to consult a consumer law attorney,” Detweiler said. “Otherwise [you] may reset the clock on these debts and owe the entire amount plus interest.”

You can get referrals to consumer law attorneys at the National Assn. of Consumer Advocates, http://www.naca.net.

You don’t have to pay the reported debts in full to reach a settlement, Bovee and Detweiler agreed. Often the totals reported are inflated by interest and fees, and the collection agencies probably paid only pennies on the dollar to buy this debt.

Start by saying you have only so much money to work with and offer 20% to 30% of what the agency says you owe.

“A realistic expectation for negotiating a debt this old would be to settle the account for 50% or less than the current balance owed,” Bovee said. “If they raise objections, there is no problem in mentioning that you are aware that the debt is past the statute of limitations for you to be sued, but that you are just trying to do the right thing.”

Don’t say you’re trying to improve your credit, since that gives the collector leverage over you, Bovee said.

You can negotiate to have the collections deleted from your credit reports, but the original delinquencies and charge-offs will remain and will continue to affect your credit scores until they pass the seven-year mark.