An Overview of Debt Settlement Versus Bankruptcy!: What Do You Need To Know About Negotiating Unsecured Consumer Debt?
As an attorney practicing in the areas of consumer debt negotiation and settlement and bankruptcy, I frequently wish my clients had come to me sooner for advice or assistance. So, I decided to write this article based on my experiences in consumer debt settlement negotiations with banks, finance companies and credit card companies.
It's divided into two parts: Part I: Before You Hit The Wall! What Should I do? and Part II: After You've Hit The Wall! What Now?
Highlights:
The article is designed to explore in general terms what you should know about how to approach this problem. Every situation is unique and nobody can give more than general advice without expert knowledge of your unique situation. Therefore this should NOT be considered as legal advice and you should not rely on any general advice in lieu of expert legal counsel familiar with your situation. But, with that in mind, here are some things to consider.
Introduction:
The economy staggers along from month to month with high unemployment, the housing market is in the doldrums, it's a wearily familiar picture. Consumer debt continues to go up as cash strapped people tap whatever credit or savings reserves they have left to pay bills.
But, what happens when you just can't make the minimum monthly payments anymore?
- Can you negotiate with banks and credit card companies? Mortgage companies?
- How? What can you expect?
- What expert advice do you really need? When should you call upon that adviser? What should you do first?
- What options do you really have?
FIRST SOME BASICS: IT'S ALL ABOUT LEVERAGE!
As any expert negotiator will tell you, all negotiations are about leverage -- who has it and who doesn't.
What They Want: When you have defaulted in paying a consumer debt ontime, the creditor doesn't want to give up any portion of their claim.They want you to pay in full. With interest and penalties.
What you want: If you cannot pay the full amount of your debt and the high interest rates that come with default, you want to make a deal whereby you can pay off your debts at a reduced amount you can afford, and get a fresh start. Or, you want to discharge your debts entirely in bankruptcy and start with a clean slate.
But who has the leverage?
THE RULE: Generally, unless you can realistically threaten the creditor with losing more money by refusing to cut a deal with you than they will lose by settling with you for a reduced amount, they won't do it.
Why should they?
Thus, part of their leverage in trying to get you to pay everything is:
a. Harm to your credit rating. They report your account as in default to the credit reporting agencies. Until paid in full or settled this information will stay on your record for years, lowering your credit score and making it more difficult for you to get consumer loans or a mortgage.
b. Harassment. They call you all the time, send nasty letters and e-mails. They may contact relatives, friends or employers. Some (but not all) of these practices are in violation of the Fair Debt Practices Collection Act, but often they do it anyway because few consumers are aware of their rights and fewer effectively enforce them.
You should know your rights in this area.
Some attorneys make a good living suing creditors who violate this act. (You will need to contact an attorney who practices in your state).
However, even if you win, suing harassing creditors doesn't deal with the underlying debt problem. An attorney can stop the harassment however.
c. Threatening to Sue. They may threaten to file a lawsuit against you unless you pay them.
d. Filing a Lawsuit. The creditor sues you and tries to collect a judgment by garnishing your wages, foreclosing on your residence and/or seizing your bank accounts and any other assets you may possess.
e. Sit and Wait. They can simply sit on the debt for the statute of limitations period (years) without filing a lawsuit try to wait you out. They hope that either you will eventually acquire some assets they can seize or get a job where they can garnish your wages, or else you will get tired of the black mark on your credit and agree to pay them.
What's Your Leverage?
- Your leverage has to be that you are unable to pay and they will be unable to collect the full amount in any reasonable time by the above means, so they should cut a deal with you, take their losses and get what they can.
- Additionally, if you can realistically threaten them that you are going to proceed with a bankruptcy, they may be forced to accept less they would like to avoid becoming an unsecured creditor in a chapter 7 bankruptcy case. (More on this below).
However, for YOUR leverage to work, you first need to be able to protect yourself from THEIR leverage in order to force them to deal with you, rather than, say, suing you to collect the debt.
They will generally do whatever looks easiest, and most cost effective to them. Normally, that's damage your credit rating, threaten and harass you and ultimately sue you to collect the full debt or sell your debt to some debt collector that will do the same.
There are only three ways to successfully fend off creditors:
1. Remain judgment proof. If you have little or no assets, rent instead of own your own home, and you are self-employed, then creditors cannot garnish your wages or seize your house or assets.
Needless to say this does not apply to everybody. Also the amount of exempt assets you can keep from creditors varies according to state law in the state where you live. For interest, cars worth more than a certain amount may be non-exempt (the creditor may be able to seize and sell your vehicle).
It also won't protect you from harassment, court orders to fill out interrogatories about your assets and other creditor demands. Creditors can also file to renew their judgment for many years.
2. Negotiate a Settlement. Obviously if you get them to agree to take a reduced amount in full satisfaction of their claim, then that solves the problem. The debt is reported as "settled" to the credit reporting agencies -- which is better than a bankruptcy.
3. Bankruptcy. If you are able to discharge your debts in bankruptcy under Chapter 7 then you won't have to pay them. If you file for a chapter 13 repayment plan you will be able to pay a portion of your debt depending on your assets and income, over a period of years.
(This whole area is extremely complicated and you need an attorney to analyze your situation properly if you are considering bankruptcy. Under no circumstances should you try to do it yourself).
Part I: BEFORE You Hit The Wall What Should You Do?
There IS hope. You do have options.
I don't want to suggest that you have to take these options in stages: i.e. first budgeting and reducing expenses, second try-it-yourself negotiations, third, hire a professional. You might want to consider having someone negotiate for you rather than suffer the brain damage of doing it yourself.
OPTION 1: Budgeting and Reducing Expenses.
Most all of my clients are actually well past this stage when I first talk to them. But there ARE some things you can do if you catch the problems early enough. If you have tried all these strategies and are in even deeper trouble, then you might want to skip ahead to the more serious remedies. But these are things you can do without hiring an expert to help.
There are a LOT of articles with advice about how you can "do it yourself." Depending on how deep in the well you are, they may be of use. But, the MOST important thing is to be HONEST with yourself. The worst mistake people often make is not having a plan and not admitting to themselves that they need professional help early enough! Waiting until you have ZERO assets left, not even enough money to declare bankruptcy, leaves you really without options!
Example: If you've lost your job and are living on credit cards to pay the monthly bills in the hopes of finding a new job, and this situation lasts more than 1 month, then budgeting your expenses and eliminating unnecessary expenses, will probably NOT work for you, and you will need expert help. Don't wait 6 months until you totally run out of money and available credit, and your debts have mushroomed!
I don't have a lot of advice on setting realistic budgets and living within them.
Anybody who has seriously considered talking to outside counselors has probably explored those options, but if you haven't made up a written household budget that's a good place to start.
If you're not going to be able to pay off your debts in a reasonable time (ex: 2 or 3 years, leaving you with at least some discretionary income so you're not simply slaving away to pay creditors for years and years -- a kind of debtor's prison) no matter what you do with your budget, then it's time to think about more serious debt relief.
If you are in Real Trouble, Be Realistic And Admit It Early! Don't Keep Waiting & Hoping That "Something Will Turn Up" to Save You!
And, if you're way over your head, don't attempt to bail out the ocean with a thimble! Get help now!
OPTION 2: Do It Yourself Debt Negotiation!
Caveat: There's LOTS of information out there on negotiating for yourself with banks & credit card companies. I can only summarize briefly here.
Once again YOUR SITUATION MAY VARY CONSIDERABLY. That's why I use words like "generally" -- because there's no certainty about these matters. For instance, a creditor could decide to file a lawsuit against you within 3 months. They generally won't do that, but someone could.
The following advice is MOSTLY applicable to UNSECURED debt -- ex: credit card where the creditor does not have a security interest (ex: mortgage deed of trust) on any specific asset. Secured creditors have a simply remedy: they can seize the asset they have a security interest in: your house, repossess your car, etc. At that point if you still owe them more money, in some, states (including Colorado) but not all states,they can sue you to collect the remaining balance.
Dealing With Secured Creditors: If you are in default and owe more than your house or car is worth, you are facing the potential for a deficiency judgment. MUST get the advice from a knowledgeable attorney in your state. This may save you a LOT of money down the road!
I am not dealing with how to negotiate with secured creditors in this article.
Given all the difficulties in successfully negotiating debt reduction yourself outlined below, you might wish to hire a professional, because time is a crucial element.
However, if your consumer debt is less than $10,000 you may want to consider doing your own negotiating, despite the difficulties, because after you pay a debt consolidation company or an attorney for debt negotiation or bankruptcy your savings may be minimal or you might even spend more money than you save. You should talk to a professional about this and try to figure out what it will cost you, versus what you might save.
If you have multiple accounts, if someone is threatening to sue you, or if your debt is considerably more than $10,000 (among other factors) you should seriously consider hiring an attorney to represent you in debt negotiations.
IMPORTANT POINT #1: Looking at things from the creditor's point of view:
Banks & Credit Card Companies are not charities! Don't expect them to do anything to "help you out." Their job is to collect their money as quickly and effectively as possible. Whether you have to eat cat-food to do it is no concern of theirs!
Thus, as long as you are paying regularly, why should they "work" with you? Even if it's the minimum amount. Even if you're only paying interest. What incentive do they have? Not until you stop paying and create a problem for THEM are they generally willing to negotiate. And the longer the problem goes unresolved, the more inclined they may have to be to settle.
But, BEWARE! Most creditors are not just going to sit there waiting until you are able to pay them! They'll eventually take action to forcibly collect the money from you.
Difficulties With Consumer Negotiations: Due to the downturn in the economy banks and credit card companies are simply SWAMPED with defaulting debtors. They have had to set up automated departments simply to deal with the crush and thus it can be both difficult and time consuming just to get to speak with a live person. Often the person you speak with over the phone has no authority to negotiate anything. Instead they have an automated script they go through by rote.
As an attorney I am often able to threaten them enough to get transferred to talk with their bankruptcy department, which usually has more knowledgeable people who are willing to work out a deal -- but by no means always! If you are not represented by an attorney they generally start by giving you "the script".
The Script:
1. First they want you to make minimum monthly payments and arrange to catch up any arrears (with interest and penalties).
2. If you cannot manage this, they ask you to send them tons of personal financial data, then they may agree to consider you for a "hardship" status. (More on what that means later). Meanwhile they will often ask you to make a minimum payment to keep your account current or prevent the account from being sent to an outside collection agency (as if they weren't in control of that themselves -- in short they're asking you to pay money you can't afford to pay, in order to save you from the consequences of their own bureaucratic procedures (Ex: "we send these accounts out after 90 days." What, are you saying? You can't control what you do with this account??)
If you make the minimum payment, there is NO guarantee you will then be able to reach a suitable agreement, and they will keep your money in any case. (This is actually a favorite trick of banks with mortgage borrowers trying to re-negotiate their loans).
The brain damage they put you through is not entirely accidental. Part of their tactics are to wear you down by making things as difficult, frustrating and downright exhausting as they possibly can, in the hopes that eventually you will give up and just pay them.
THE TIMETABLE:
First 90 Days: Generally, for up to 90 days after you've missed a payment you will get progressively more nasty letters. During this period they will probably jack your interest rates to the moon and add late fees and charges. You should certainly NOT be using these accounts and credit lines at this point.
Prior To Charge-Off: After 90 days, they may have an in-house collection department that takes up calling, writing and e-mailing you. Alternatively, they may farm it out to a collection agency. At this point, the debt is being collected by an outside company, but is still owned by the original creditor.
CREDITOR 101: At this point, generally speaking, banks and credit card companies will still NOT concede any of the principal balance on your debt in negotiations with you. If you seriously cannot pay they may consider you a "hardship" candidate, which generally means that you submit lots of financial information about your job status, assets, bank accounts, social security numbers, date of birth, etc. All this info will be of great assistance to them if they later decide to sue you! (That's why they're forced to have those recorded messages: "You should be advised that we are trying to collect a debt. Any information obtained will be used for that purpose."
Settlement Agreement: Then, depending on the company they may close your account, stop the interest charges and penalties, and permit you to pay off your account over time. That's probably about the best you can expect. Naturally, this will be reflected on your credit report until paid in full.
Some creditors may be willing to waive interest charges. This is more likely with credit card companies than banks (with lines of credit), because the credit card companies jack their fees, penalties and interest so high upon default that they are often only agreeing to waive their extra fees and interest!
Also at this point, if you appear to be serious about filing for bankruptcy, you MAY be able to get the creditor to negotiate a cash settlement. Most individuals will find it difficult to get the creditor to accept this, and generally around 50% - 75% is what you can expect to have to repay.
Often this is because if you tell them you are considering filing for bankruptcy, they will ask for the name of your attorney. If you tell tell them you don't have one, they've just called your bluff. They consider you not serious. Once you've actually retained an attorney, and refer all your communications with them to that attorney, then they take the threat of bankruptcy more seriously.
Part II -- What To Do After You've Hit The Wall!
What do you do if you've tried to negotiate with the bank or credit card company and been unsuccessful? Or What if you have multiple accounts, more than $10,000 in debt or other serious issues (someone is threatening to sue you for instance).
At this point you basically have two options:
1. Hire a debt negotiation company like one of the many you see advertising on TV and over the internet.
2. Hire an attorney to defend against a lawsuit, as well as pursue either a debt negotiation settlement or a bankruptcy.
Some Considerations:
1. If you own less than $10,000 in consumer debt, you may want to consider doing it yourself rather than hiring a professional. The cost of hiring someone to represent you may overwhelm any savings you might make by writing off even a significant portion of your debt.
But, if this fails (or if someone is threatening to file a lawsuit against you, you may have to seek outside help.
WARNING: You should never try and defend a consumer debt lawsuit by yourself. An attorney can file an Answer forcing the creditor to wait and then negotiate a settlement suitable to you. (Remember the concept of leverage). If you try this yourself they will often try and get a judgment against you without a trial by various tactics.
More on this below.
Option 3 Hire An Attorney To Defend And Represent You In Debt Settlement Negotiations!
If you cannot or prefer not to negotiate an acceptable settlement yourself, and especially if you have multiple accounts, have more than $10,000 in credit card debt, or are threatened with a lawsuit (or actually have been served with a lawsuit) then you need to hire a professional.
An attorney who handles debt collection settlement and defends debtors as well as handles bankruptcy is really what you need.
If You've Been Sued For A Consumer Debt You Need An Attorney!
If you attempt to defend yourself in a lawsuit, the creditor will often try and move for judgment on the pleadings or summary judgment (i.e. they want to get a judgment against you without the expense of a trial). Your attorney can fight these attempts, but you'd be hard pressed to handle them yourself.
What can an attorney do for you in debt negotiation settlement and what will it cost?
The cost will vary depending on your state and location. Some attorneys will charge an hourly fee, but many may offer you a flat rate for each account. This rate may vary according to the amount of debt to be negotiated. This flat rate is helpful since it lets you know up front how much you will have to pay in attorney fees.You should ask the attorney up front how they charge and what their fees will be. You should get this information in the first 5 minutes, before you make any commitments.
Beware of anybody who tries to suck you in with a line about "low monthly fees" without specifying at least a probable overall amount! Most attorneys won't do that but "Debt Settlement" companies are notorious for that very thing. Not knowing up-front what it's liable to cost you is a sure way to become disgruntled.
What To Look For In Fee Arrangements And What To Expect In Settlement Agreements!
If they get paid every month until your account is settled, you may not be happy with how long the negotiation period lasts!
What you want to know is "how much is this going to cost me and what sort of settlement can I expect?"
Simply as an example, for instance, I normally try and negotiate a settlement on unsecured consumer debt between around 20% and 30% of the total balance. This may be more or less depending on circumstances.But, if the debtor is a good candidate for bankruptcy the creditor (or debt collection company) will often negotiate down the total balance to something they would never consider if the debtor had not hired an attorney who threatened them with bankruptcy.
Why?
Because if the debtor lacks significant assets (upside down on her mortgage or doesn't own her own home for instance) then the unsecured creditor is not likely to get very much in a Chapter 7 case (often 10% or less depending on the case). Thus, the creditor has an incentive to negotiate a cash deal now, rather than wait 6 months or a year or more and then receive only pennies on the dollar while the debt is discharged in bankruptcy.This is a VERY effective negotiating tactic. But, to be a credible threat, you probably need an attorney to represent you.
The very fact that the debtor has hired a lawyer is an indication that the debtor is serious about bankruptcy. Often this will make the creditor accept a deal they would not accept from the debtor herself.
Other advantages to hiring an attorney:
Sometimes the debt negotiation takes a long time. Not every creditor will be willing to accept what you can afford -- at the same time. Some might hold out for months or even years in the hopes of forcing you to pay 100% of the debt, while others might be willing to deal now. It's almost impossible to get multiple creditors to accept reasonable settlements at the exact same time. There are dozens of ramifications to this impossible to spell out in detail in this article.
Bottom Line: these negotiations can take time.
Generally the BEST deal you can negotiate is a straight cash settlement. Cash now on the barrel-head. Creditors will almost always offer you a lower percentage settlement if you can offer an immediate cash payment, rather than spreading the payment out over time.
But, obviously, the debtor may not have sufficient funds to settle all their accounts at the same time in this fashion -- even when settling for 20% or 30% of the total amount. What then?
Well, there's the danger that while the debtor is spending all their available cash to pay off creditor #1, creditor #2 will sue them! Then you really have a problem, because you've already paid #1 and suddenly need to deal with the 2nd creditor!
An attorney can defend the lawsuit, set a trial date for months later and then try and settle the case for you. It's surprising how often creditors don't even have the basic information to prove their case, and in any event in many cases they'd prefer to settle a case rather than go to the time and expense of litigation. I've had cases where the creditor simply dismissed the lawsuit rather than proceed with a trial! They had other easier fish to catch, why waste effort on this one? (That's not always the case by any means, but it does happen).
What If Efforts To Settle Are Still Unsuccessful? Or if I'd Have To Spend Too Much Money To Defend A Lawsuit?
If efforts to settle are unsuccessful you can always have your attorney file for bankruptcy (assuming you qualify -- here you need expert advice from a knowledgeable bankruptcy lawyer in your state).
At that point, the creditor will be hit by the automatic bankruptcy stay -- this simply stops all legal proceedings against you for a time. Discussion of the Bankruptcy process is beyond the scope of this article -- again you need expert advice here.
But, the creditor, knowing this, has an incentive NOT to sue you only to get stopped by the bankruptcy filing. This alone will probably delay things for some months - hopefully until you are either ready to settle or file your bankruptcy.
Why Debt Consolidation Companies Generally Don't Work!
What about hiring a "Debt Settlement" company instead of an attorney? Isn't that cheaper.
Er. No.
It seems to me that these companies actually charge MORE than most lawyers would dare charge! Lawyers are bounded by the ethics rules enforced by the Supreme Court licensing board of their state. Their fees must be "reasonable" or they are subject to discipline (which can include losing their license). That tends to put a damper on some of the more "creative" methods of squeezing money out of clients.
Debt Settlement companies don't seem to be bound by any of these concerns. They are generally unregulated and not subject to the same kinds of disciplinary actions as lawyers. And if they take your money, fail to do anything for you, and refuse to refund it, (unlike lawyers) you may be left without an effective remedy.
I suppose I should start by saying that those "debt relief" and "debt negotiation" and "debt consolidation" companies you see on TV MAY or MAY NOT be able to help you. My clients' experiences with these types of companies have been pretty uniformly bad and personally I'm shocked by some of their practices. I'd be disbarred if I did some of the things that I've seen them routinely get away with. So, I take a distinctly skeptical view of that entire industry. I think Congress will eventually have to severely regulate this entire area from the standpoint of consumer protection. But that's a topic for another day.
I would be VERY WARY of signing up with any of these slick operators.
Lawyers are subject to ethics requirements that would prevent us from ever using such deceptive advertising making false promises as "100% guaranteed" or "find debt relief in 60 seconds." But apparently "Debt Settlement Companies" that are not law-firms are free from such ethics rules.
Isn't it great? The nice man got rid of all our debt! The Reality: These companies tend to be nationwide, so you're most likely talking over the phone with a person who might live in Cleveland whom you will probably never see.
Isn't it great? The nice man got rid of all our debt! The Reality: These companies tend to be nationwide, so you're most likely talking over the phone with a person who might live in Cleveland whom you will probably never see.
What's the Catch?
Here's a typical sales pitch taken from the internet:
"We will provide you with one low, affordable monthly payment. Based on your monthly budget, one of our debt analysts will be able to set you up with affordable payments considerably less than you're paying now.
"Our proven debt arbitration strategies have helped many Americans in need of debt relief. If you're ready to put an end to debt related problems, and want to avoid the possible pitfalls of bankruptcy, call us today.
"Your creditors win by resolving your outstanding balances. We win by Reducing your debt amount. And most importantly, you win by saving thousands of dollars and years of stress and anxiety wondering if you will ever free yourself of debt!"
Sounds great right? Notice that they suck you in by getting you to pay into an account with them on a monthly basis. They take (usually) a monthly fee out of the money you deposit with them. They then use the balance to negotiate with your credit card company or bank on your behalf.
MILLION DOLLAR QUESTION: What happens if you don't have enough money available to settle your account right now -- even a portion of it?
ANSWER: They will "wait" until your balance is sufficient to settle your account BEFORE negotiating a settlement. What happens in the meantime? Your debt is often charged off (CO) by your original creditor to a collection agency who can then threaten to sue you.
WHAT'S WRONG WITH WAITING? Many of my debt negotiations take a year or more to settle, especially if the client has multiple accounts. What if the creditor/collection agency sues you in the meantime? Can these "debt settlement" companies protect you from a lawsuit?
Generally, NO! They're not lawyers and they most likely won't defend you. They might connect you with an attorney in your state who will charge you additional fees (probably several thousand dollars to start with). If you're going to wind up with a lawyer, why not hire one upfront?
TRUE EXPERIENCE: I had a client who came to me after paying over $3,800 to a "debt negotiation" company over a period of several months -- and that was just to cover their "fees". He thought they were taking his money to settle the account, but they told him his settlement account with them was never large enough to settle the debt, so they never actually did anything at all! They just kept thousands of dollars in monthly "fees" -- and never did ANYTHING for him!
If a lawyer tried that he could be disbarred and would deserve to be! I can't just charge a fee and never do anything to earn it! But some of these debt "negotiation" companies seem to do it routinely. I don't know, but I suppose not having an office of attorney regulation looking over their shoulders allows them to cheat people without consequence.
MORAL OF THE STORY: Make sure BEFORE YOU SIGN UP WITH ANYBODY OR GIVE ANYBODY ANY MONEY to settle your account, that you get an agreement as to EXACTLY what their total fees and costs will be. This is critical.
If they refuse to commit to any maximum figure, that's a sign that they're not ethical. If their total fees are going to exceed the figure they gave you up-front, then they should tell you BEFORE you commit to further efforts on their part that will generate further fees. In short you should always know what you're getting and be able to say "stop!" at any point if the fees get too large.
At minimum you should be told how possible problems might necessitate larger fees (say if a creditor sues you that could be an extra fee).
Don't get sucked in by "low monthly payment" language.
- For how many months will these "low monthly payments" continue? What are their minimum and maximum fees?If the account doesn't settle for a year, are they going to keep charging you for a year? Two years?
- Do they offer a "flat fee" per account (as many lawyers do)? If so how is it based?
