Crushing Debt

Drowning in Debt?

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This question comes up about once every six months.  A client arrives at our door and wants help.  They are overwhelmed with debt.  Sometimes, it’s because they have this business that is not performing as they hoped/wanted/expected (often, because they need the structure and systems to make it so), other times because of an accident or a sudden illness.  But, no matter what the cause, we need to work together to make the situation tenable.

Crushing Debt

It is possible to work with your credit card issuer and negotiate a partial settlement, a workout agreement or even just a reduction in the bills for a few months. And, that means the constant threat – and more importantly, the constant distraction from the desired activities necessary for success- is eradicated.

But getting that credit saving deal you need won’t be a slam dunk. You (and we) face a series of phone calls and have to wrestle with details that might not seem important now, such as the impact to one’s credit line, credit history, and next year’s tax bill.

There are three key steps to renegotiating debt, and they are far from simple.  No way.

First, you need to know how much you need to live.  Rent, food, insurance, car payments, etc.  Then, you can determine what “extra money” you have.  Please don’t forget that  you must leave wiggle room for unexpected problems, too.

Once you have your budget, you have to figure out which sort of plan works for you.

There are five basic arrangements or plans to get you out of this mess: lump-sum settlement, workout arrangement, forbearance, debt management plan, and debt settlement.

Lump-sum settlement. If you have access to a chunk of money, such as from an inheritance, you can try to negotiate a settlement for less than the full amount owed to your creditors. Frequently, you can break that amount you need to pay into three payments.  A key point (because this happens way too frequently) is to ensure that the lump sum you agree to pay will absolutely satisfy the bill and to get that fact confirmed in writing.   This arrangement  still will impact your credit score depending on how the payment(s) is(are)  reported to the credit bureaus.

Should the firm effect a charge-off (which means the company removes the entire debt from its books for accounting purposes but that doesn’t eliminate your obligation), your credit score will take a big hit.  And, the IRS considers most forgiven debt to be income.  When a lender forgives at least $600 worth of the principal on your debt, it must report the amount to the IRS via a 1099-C form. So, for example, a lump sum payment of $2,500 to settle a $4,500 credit card bill will mean you’ll likely have to pay tax on an additional $2,000 of (assumed) income next year.

Consumer Debt in USA

Workout arrangement. Under a workout, the creditor eliminates or lowers both your interest rate and/or minimum monthly payment (usually both), and  stops assessing punitive fees (such as late fees or over-limit charges).  This is going to terminate the credit vehicle, so you won’t be able to use your card(s). Again, the impact to your credit score will depend on how the issuer reports the arrangement or your payments to the credit bureaus.  Dropping your credit line (if it is only one card) raises your credit utilization ratio, which lowers your credit score.  Having $10,000 in available credit on various cards, with a total of $5, 000 of indebtedness means that when you close one account with a $1,000 limit,  your credit utilization ratio changes from $5,000/$10,000 to $5,000/$9,000 (from 50% to 56%).

Forbearance program. If your financial problem is only temporary, such as a major medical event that put you out of work for a few months, then a forbearance — which is similar to a workout arrangement — could work for you.  This is exactly what I used when my fellowship was being terminated by the government four decades ago.  I had 30 days to finish my programs before my money ran out.  State Street Bank eliminated the interest fees and gave me four months with no late fees.  And, I paid the balance in full (more than $ 20 K back in the very early 1970’s) by the fifth month.  This was (and still is) NOT debt forgiveness.  This program only works well for temporary problems, a bridge to when we are once again financially stable.

Debt management program. If you don’t want to negotiate with your creditors yourself, you can opt to go through a debt management program.  Most of these firms are crooks, so it’s imperative you seek out a non-profit that’s highly ranked and affiliated with the National Foundation for Credit Counseling or the Financial Counseling Association of America (formerly known as the Association of Independent Consumer Credit Counseling Agencies). The counselor will work with the lender to restructure your debt so it’s affordable. Typically, the counselor can negotiate to lower your interest payments, reduce or drop fees, and/or lower your required payments.  You will pay the entire amount owed under this program and all your credit cards are included AND they are also closed.  Shutting down the accounts dings your credit score,  because your credit utilization ratio will be lower. But, it’s much better than bankruptcy or choosing the debt settlement program outlined below.

Debt settlement program. This is absolutely the last choice- the one right before opting for bankruptcy.  Basically, you stop paying your creditors for months, until they are ready to accept a lower payment.  I’m sure you recognize that  this is going to POISON your credit score.  But, paying a portion of what you owe is better than paying nothing.  And, the accounts will ding your score for 7 years.  And, a really annoyed credit vendor can force you into bankruptcy anyway (it’s called involuntary bankruptcy), when and if you stop paying your bills for several months.

Once you’ve chosen your path (one of the five alternatives above), you are going to have to do a lot of work.  You will spend hours on the phone finding the “right” people.  And, don’t be surprised when you reach someone who has the authority to work with you, you find that your credit limit has been frozen on the spot.

If you are dealing with a short-term problem, call the creditor yourself, explain your situation, and ask for help.  If it’s a long-term problem, you might need some help from experts.   Both to solve the credit line problem- and to turn your (underlying) situation around.

If you’re doing this yourself, be prepared to call repeatedly. Remember most CSR (consumer service reps) lack the authority to make any deals with you (but never will admit that).  You need to stress you need to reach the department that handles settlements.  Sometimes that’s a workout department, sometimes it’s loss mitigation, but there’s no uniform nomenclature.

This process could take several months.  If it drags on for some 6 months, the credit issuer has probably sold your debt for pennies on the dollar (“charge-off”).  And, the folks that bought your debt will hound you forever (or until the statute of limitations kicks in).

Nevertheless, do not agonize about haggling- it’s your survival on the line. (Yes, that means turn down their first offer.)  Explain to the creditor you want to honor your obligation, and what sort of plan do they have.  (Don’t be afraid to offer your own.)

Remember, you MUST get any proposed deal in writing.  To protect yourself against changes in personnel- or, worse yet, if the creditor sells your debt.

Oh- and also remember, we are here to help you through the process.

Roy A. Ackerman, Ph.D., E.A.

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