There are many different forms of Debt Negotiation and Debt Settlement. For that reason it is difficult to give a general overview of something with many different variations. However, almost all forms of debt settlement and debt negotiation involve you attempting to reach an agreement with your creditors to pay them less than the full amount. This is something that you can easily do yourself; however, many people still go to one of the numerous companies out there for help.
This industry has become very profitable and for that reason many companies have been sprouting up every day that might not have an established reputation. The Law Offices of Daniel L. Warren will rarely advise someone to use debt settlement companies due to the many risks involved and lack of benefits it can produce.
The way a debt settlement company works is by promising you that they can settle all, or a majority, of your debt for a reduced percentage. Usually the percentage they will promise you can be anywhere between 10-60% of your total debt. So let’s say you have $10,000 in credit card debt, they might promise to settle it for you for $5,000. The way they tell you that you can accomplish this is by paying them a monthly fee and stopping all payments on your credit card. So you might need to pay the debt settlement company $400 per month for a year or more before they can settle your debt. Then what they do is take the money you have paid them over that time period and make an offer to the credit card company for a lump sum payment.
So now you have to reflect and ask yourself what exactly just happened? (1) You have missed your payments on credit cards for a very long period of time. (2) You have been paying a company to hold on to your money and take a fee or percentage on top of what you are paying the credit card companies. (3) So in the end you have destroyed your credit by missing payments for the previous year or longer, and although your credit cards might be paid off they will all be reported on your credit report as “debt paid for less than the full amount” which is terrible for credit scores and credit worthiness.
Bankruptcy vs. Debt Settlement – Which is better for you?
When someone is in a difficult financial situation their credit usually becomes severely at risk of being damaged. Most people understand and accept this fact. So it is in your best interest to be well informed with how your credit will be affected.
Many debt settlement companies try to persuade people to not file bankruptcy and convince them it is the worst thing that can happen to you in terms of credit. Additionally the general public does not know very much about bankruptcy, therefore, a negative stigma is attached to bankruptcy.
The truth that most of these companies do not want you to know is that bankruptcy is usually the better option for people that are in moderate to severe debt. The reasons for this are explained below:
Future Credit Worthiness
Participating in debt settlement will certainly destroy your current credit. But more importantly it will severely diminish your subsequent future credit worthiness. The reason for this is that your credit now reflects missing many payments on likely all of your accounts for an extended period of time. Furthermore, each debt is likely to have been reported by the credit card company as “debt paid for less than full amount” or “settlement for less than full amount.” Either way it will extremely drop your credit score and worthiness. To potential lenders you will still be viewed as a person to whom it is risky to lend money or extend credit. The lenders will view you as likely to repeat your history in the future and therefore. And the lender will always view you as a likely candidate for bankruptcy. Lenders never want to extend credit to anyone whom they believe might soon be filing bankruptcy.
The difference with bankruptcy is you get to start over with a clean slate! Under the Bankruptcy Code a person is not allowed to receive a discharge under Chapter 7 bankruptcy more than 1 time within an 8 year period. For this reason lenders know that you are a safe bet to extend credit to. Lenders know that the newly assigned credit will not be going anywhere for at least the next 8 years. Lenders always prefer to extend you credit immediately after a bankruptcy, rather than right before. For this reason it is much easier to rebuild your credit after a bankruptcy as opposed to debt settlement. When receiving credit terms after filing a bankruptcy you will have higher interest rates than someone with good credit. With debt settlement you will also have very high interest rates, but your likelihood of even being approved is much lower.
At The Law Offices of Daniel L. Warren we not only help you file bankruptcy. But our goal is to help you get a fresh start and rebuild your life. We offer all our clients advise on how to best rebuild your credit and get back on the right track. A number of our clients have had FICO scores over 700 within just a few months of receiving their discharge. If you take the right steps you can be on the right path to rebuilding your life and repairing your credit.
Judgments
One of the largest concerns an individual should have when they are in serious debt is of law suits. When you have accrued debts that have been delinquent for an extended period of time it is very probable the lender will sue you in order to receive a judgment against you. The reason lenders do this is because of the power that comes with a judgment. A debt is usually only collectable and reportable to your credit for a 7 year period. However, a judgment in California is good for 10 years and can be renewed for another 10 years. Thus, it allows the lender up to 20 years to collect on the debt. Furthermore, a judgment can be used to garnish wages, attach a lien to property, and sometimes even freeze bank accounts.
When dealing with debt settlement you are going for extended periods of time without making any monthly payments. Therefore the chances of you being sued and a judgment against you being entered is exponentially increased. Debt settlement companies will tell you that this won’t happen, but they have no power to stop it. The decision to bring the law suit is at the sole discretion of the lender. If the lender has concerns that they will not be paid they will go through with the law suit despite what a debt settlement company might tell you.
Bankruptcy prevents any lender from suing you or receiving a judgment against you for debts that were incurred prior to your filing for bankruptcy. Additionally, bankruptcy also has the ability to freeze any pending law suits against you while you are in bankruptcy. And finally, bankruptcy also has the unique ability to vacate any judgments against you that have already been entered. Bankruptcy has the power to strip liens and stop garnishments as well. These are areas that debt settlement cannot address.
Tax Consequences
What almost everyone who goes through debt settlement fails to take in to consideration are tax consequences. Debt negotiation companies are very good at forgetting to address this concern to its clients.
The reality is that the U.S. Internal Revenue Service (IRS) considers forgiven or canceled debt as income. Creditors and debt collectors who agree to accept at least $600 less than the original balance are required by law to file 1099-C forms with the IRS and to send debtors notices as well. Taxpayers must report that “income” on their federal income tax returns. The 1099-C is a form used for any cancelled, or forgiven debt. In other words, if you have $50,000 in debt, and you settle with the credit card company to pay $30,000 (60% of the original debt) that means you will have saved $20,000. However, the IRS now views that $20,000 as income for that tax year, and you are expected to pay on it as you would any regular income! The only way you can avoid that is by showing insolvency to the IRS, which is not possible in every case.
Recent Rule Change Prohibiting Debt Settlement Companies from Collecting Upfront Fees
Due to the continuous complaints and problems arising from consumers use of Debt Settlement companies the Federal Trade Commision (FTC) has instituted a new rule taking effect October 27, 2010.
The FTC notice states the following,
“Starting on October 27, 2010, for-profit companies that sell debt relief services over the telephone may no longer charge a fee before they settle or reduce a customer’s credit card or other unsecured debt.
“At the FTC we strive every day to make sure America’s middle class families get straight deals for their dollars,” Chairman Jon Leibowitz said. “This rule will stop companies who offer consumers false promises of reducing credit card debts by half or more in exchange for large, up-front fees. Too many of these companies pick the last dollar out of consumers’ pockets – and far from leaving them better off, push them deeper into debt, even bankruptcy.”
Three other Telemarketing Sales Rule provisions to take effect on September 27, 2010, will:
· require debt relief companies to make specific disclosures to consumers;
· prohibit them from making misrepresentations; an
· extend the Telemarketing Sales Rule to cover calls consumers make to these firms in response to debt relief advertising.
The Final Rule covers telemarketers of for-profit debt relief services, including credit counseling, debt settlement, and debt negotiation services. The Final Rule does not cover nonprofit firms, but does cover companies that falsely claim nonprofit status. Over the past decade, the FTC and state enforcers have brought a combined 259 cases to stop deceptive and abusive practices by debt relief providers that have targeted consumers in financial distress.
Advance Fee Ban
The Final Rule contains specific requirements for debt relief providers related to charging an advance fee before providing any services. It specifies that fees for debt relief services may not be collected until:
· the debt relief service successfully renegotiates, settles, reduces, or otherwise changes the terms of at least one of the consumer’s debts;
· there is a written settlement agreement, debt management plan, or other agreement between the consumer and the creditor, and the consumer has agreed to it; and
· the consumer has made at least one payment to the creditor as a result of the agreement negotiated by the debt relief provider.
To ensure that debt relief providers do not front-load their fees if a consumer has enrolled multiple debts in one debt relief program, the Final Rule specifies how debt relief providers can collect their fee for each settled debt. First, the provider’s fee for a single debt must be in proportion to the total fee that would be charged if all of the debts had been settled. Alternatively, if the provider bases its fee on the percentage of what the consumer saves as result of using its services, the percentage charged must be the same for each of the consumer’s debts.
Dedicated Account for Fees and Savings
Another new provision of the Final Rule will allow debt relief companies to require that consumers set aside their fees and savings for payment to creditors in a “dedicated account.” However, providers may only require a dedicated account as long as five conditions are met:
· the dedicated account is maintained at an insured financial institution;
· the consumer owns the funds (including any interest accrued);
· the consumer can withdraw the funds at any time without penalty;
· the provider does not own or control or have any affiliation with the company administering the account; and
· the provider does not exchange any referral fees with the company administering the account.
Disclosures and Prohibited Misrepresentations
Under the Final Rule, providers will have to make several disclosures when telemarketing their services to consumers. Before the consumer signs up for any debt relief service, providers must disclose fundamental aspects of their services, including how long it will take for consumers to see results, how much it will cost, the negative consequences that could result from using debt relief services, and key information about dedicated accounts if they choose to require them.
The Final Rule also prohibits misrepresentations about any debt relief service, including success rates and whether the provider is a nonprofit entity. The FTC’s Statement of Basis and Purpose, which accompanies the Final Rule, provides extensive guidance about the evidence providers must have to make advertising claims commonly used in selling debt relief services.
The Rulemaking Process
In August 2009, the FTC published in the Federal Register a notice of proposed rulemaking proposing amendments to the Telemarketing Sales Rule and requesting public comments. Over 300 commenters, representing a wide variety of stakeholders, submitted comments in response. The Commission also held a public forum on the proposed amendments on November 4, 2009. The FTC developed the Final Rule based on the public comments, the record of the public forum and the FTC’s September 2008 Workshop on the debt settlement industry, recent testimony before Congress, and law enforcement actions brought by the Commission and the states.”
To view this notice in its entirety please visit http://www.ftc.gov/opa/2010/07/tsr.shtm
