1. What is a debt settlement company? How do these companies work? How much do they charge? Should I use one to get rid of my credit card debt?
A: Debt settlement companies work as a middleman between you and your creditor. If all goes well (and that’s a big if), you should be able to settle your debts for cents on the dollar. You’ll also pay a fee to the debt settlement company, usually either a percentage of the total debt you have or a percentage of the total amount forgiven.
If you’d asked me a few years ago about debt settlement companies, I probably would have told you to avoid them. But things have changed a bit. The Bankruptcy Reform Act of 2005 made it harder for individuals to file bankruptcy, which is always the last resort.
Unfortunately, simultaneously consumers racked up so much debt that counseling companies—which are higher up on my list if you need help managing your debt—are sometimes unable to help. So if you fall into this camp, debt settlement may be something to consider.
Here’s how it works: The debt settlement company will direct you to stop paying your creditor and instead send the money directly to them each month. The company’s goal is to demonstrate to your creditor that you don’t have the money to pay up—that’s your leverage. After a few months, the company will typically go to the creditor and say, “I’m holding X dollars on behalf of your customer. He doesn’t have the money to pay you, so you should take this amount as a settlement or you’ll end up with nothing.” If the creditor wants to get paid badly enough, it will take the money.
All of this sounds great, but there are negatives. For starters, during the three-to four-month stretch that you’re not paying your creditor, your account will accrue late fees and possibly even “over the limit” fees. Both of those fees add to the total debt and to the debt settlement company’s fee. Not paying your creditors can do a serious number on your credit score, and having a settlement on your credit history drags it down even further. If you start out in the high 600s, for example, your credit score could be well into the 400s by the time you’ve gone through debt settlement, especially if you settle more than one account.
And besides: You really don’t need to hire a debt settlement company to negotiate with your creditors. Unless you have multiple accounts that you need to negotiate and you think the project is just too big to tackle on your own, you’re better off just calling your creditors directly. For what to say, see the script included with the next question.
I Also Need to Know…
Q: How much is working with a debt settlement company likely to cost me?
A: To be honest, you might have trouble getting a straight-up answer to this question even from the debt settlement company itself, and if you do, that’s a reason to walk away. The best companies will charge a percentage, usually about 15%, of the amount of debt that they’re able to settle for you. Others may charge 15% of the total debt you have when you enter the program. If the fee is calculated this way, not only are you paying too much but you’re also not holding the company accountable to get you the best results.
But if you are able to settle, you’ll be getting off rather easy. Debt settlement companies can sometimes get you off the hook for a large percentage of your debt—in many cases, up to 50% will be written off.
Q: How long will the settlement stay on my credit report?
A: That you settled a debt instead of paying in full will stay on your credit report for as long as the individual accounts are reported, which is typically seven years from the date that the account was settled. Unlike with bankruptcy, there isn’t a separate line on your credit report dedicated to debt settlement, so each account settled will be listed as a charge-off. If a debt has gone into collection, it will be on your report for 7½ years from the date you fell behind with your creditor.
Q: How can I check a debt settlement company’s credibility?
A: For starters, make sure that the company is a member of The Association of Settlement Companies (TASC), a trade association that represents debt settlement firms and outlines standards that they agree to meet. The association has a search tool on its Web site that allows you to find a registered member in your area. Once you’ve pinpointed a few viable choices, ask for an initial consultation. You should also make sure the company has a clean record with the Better Business Bureau (BBB), which you can do at www.bbb.org/us/.
Q: Do I need a lawyer?
A: You don’t. If you’re filing bankruptcy, you will likely want to hire an attorney. But for debt settlement, a company is sufficient, or as I said, you can often do the legwork on your own.
Four Things You Need to Know About Any Debt Settlement Company
The Fee: It should be based on the amount of debt that the company is able to settle for you.
Red Flag: If the company charges a percentage of your total debt upfront, walk away.
The Return Policy: There should be a money-back guarantee in place of at least 30 days.
Red Flag: If the company doesn’t offer a guarantee, find one that does.
The Timeline: No company can promise an end date, but if you have multiple debts, the first one should be settled within a year.
Red Flag: If a company promises a faster return, it may be spinning the truth.
Where Is My Money? Once you send it to the debt settlement company, it should be kept in an FDIC-insured bank account. (The FDIC, or Federal Deposit Insurance Corporation, insures bank deposits, among other duties.)
Red Flag: If the company asks you to hold on to the money or doesn’t keep it in an insured account, the company isn’t doing its job.
An Example
You have $35,000 in credit card debt that is settled through a debt settlement company. Forty percent of your debt, or $14,000, is forgiven, and you pay $21,000 in full upfront. The debt settlement company charges you 15% of the amount of debt that is forgiven, or $2,100.
2. How do you negotiate with a credit card company? What happens when you settle your debts for less than you owe?
A: I’ve been seeing this question more with every passing week. You fall a bit behind on a credit card bill, your interest rate soars, your minimum payment rises, and you start falling more and more behind every month. You don’t see an end. But you don’t want to file bankruptcy either. What you can do—and should do—is negotiate. Here are the steps.
One thing I want to make clear: You never want to hide from your debts. It doesn’t work. You’ll get much better results by being upfront, answering their calls, and responding to their letters. Delaying the inevitable only digs a deeper hole.
I Also Need to Know…
Q: Does negotiating a settlement hurt my credit score?
A: It will. Once the settlement is completed, the credit card company will report it to the credit bureaus, which will then make a notation on your credit report that that account was paid by settlement. That’s going to signal to future lenders that you left the last guy hanging. That’s why, as with bankruptcy, debt settlement is an extreme option, one you shouldn’t take lightly. It’s not just an easy, cheap way to eliminate debt.
Q: Are there tax liabilities?
A: In many cases, yes. Most people don’t know this, but if you settle a debt for less than the amount you owed, you are potentially responsible for taxes on the forgiven debt. Look at it this way: You received goods and services for the full amount of debt, but you’re only paying for a portion of it—sometimes less than 50%. Anything more than $600 is generally considered taxable, but the IRS will sometimes waive the tax if you can prove that your assets were less than your liabilities when the debt was settled.
3. Should I consolidate my debts?
A: Rolling all of your debts into a single loan is a good idea—in theory. In fact, it can be a great idea. But before you move forward, you need to be certain of two things: (1) that this consolidation makes sense financially and (2) that it makes sense for you personally.
A consolidation makes sense only if you can lower your overall interest rate. Many people consolidate by taking out a home equity line loan or home equity line of credit (HELOC), refinancing a mortgage, or taking out a personal loan. They then use this cheaper debt to pay off more expensive debt, most frequently credit card loans, but also auto loans, private student loans, or other debt.
You also need to understand that when you consolidate credit card debt into mortgage debt—like a home equity loan or a HELOC—you’re taking an unsecured debt and turning it into a secured debt. If you default on an unsecured debt, you won’t lose anything (except points on your credit score). When you default on a secured debt, the creditor takes the asset that backs up that debt. When you convert credit card debt to mortgage debt, you are securing that credit card debt with your home. That’s a risky proposition.
Personally, can you handle it? In about one-third of credit card consolidations, within a short period of time, the cards come back out of the wallet, and in no time at all, they’re charged back up. Then you’re in an even worse position, because you have the credit card debt and the consolidation loan to worry about. You’re in a hole that’s twice as deep—and twice as steep.
If you have even a smidgen of doubt that you’ll be able to stay away from racking up additional debt, don’t do it. You must be sure—and I mean absolutely positive—that you have the willpower to pay off those credit cards and not use them again. If you are, consolidating at a lower interest rate can help you pay off your debt faster. But if there’s even a small chance that you’ll spiral back into debt, it’s not for you.
THE MATH
If you have $20,000 on a card with an 18% interest rate and you put $300 toward paying it off each month, it will be more than 24 years before you’re debt free. If, however, you transfer the debt to a $30,000 HELOC at an interest rate of 5.37%,* you’ll be able to pay your debt off in a little more than six years.
I Also Need to Know…
Q: In this tighter credit market, what sort of a credit score do I need to qualify?
A: Even in the days of the tightest credit in 2008, HELOCs and home equity loans were being made. The interest rate you receive, however, is contingent on your credit score. For example, according to myFICO.com, the consumer Web site of Fair Isaac Corporation, the primary creator of credit scores in the United States, the monthly payments on a 15-year, $50,000 home equity loan vary widely, depending on credit score. As you can see, borrowers with the best credit score pay 28% less each month than borrowers with the worst—and $23,940 less over the life of the loan.
15-YEAR, $50,000 HOME EQUITY LOAN
FICO SCORE: 740–850
APR: 8.150
MONTHLY PAYMENT ($): 482
FICO SCORE: 720–739
APR: 8.450
MONTHLY PAYMENT ($): 491
FICO SCORE: 700–719
APR: 8.950
MONTHLY PAYMENT ($): 506
FICO SCORE: 670–699
APR: 9.725
MONTHLY PAYMENT ($): 529
FICO SCORE: 640–669
APR: 11.225
MONTHLY PAYMENT ($): 575
FICO SCORE: 620–639
APR: 12.475
MONTHLY PAYMENT ($): 615
APR = annual percentage rate; FICO score = Fair Isaac Corporation score, or your credit score. Source: www.myFICO.com, November 24, 2008. Based on national averages.
Q: Do you have any tips for staying out of debt once I’ve consolidated?
A: I do, and in fact, even if you’re sure you have the strength to keep from backsliding, it will help to put some of these safeguards in place:
Q: What kind of loan do I want?
A: What you want, in a nutshell, is the loan that is going to give you the best interest rate. Here are the options:
Tools
Debt-reduction calculators can help you figure out how long it will take you to get out of debt by factoring your interest rate, balance, and the amount you can afford to pay each month. Two of my favorites:
Q: Are there alternatives to a home equity loan or line of credit?
A: One alternative to consider is a balance transfer—or series of them. Before you look to recast your credit card debt into a different loan altogether, make a series of phone calls to your current credit card companies asking for reductions in your interest rates. If that doesn’t work (or doesn’t work well enough), start scouting for cheaper credit cards that will allow you to transfer your balance. Ideally, you’re looking for a card that caps transfer fees (they’re typically 3% of the amount you’re moving) at $75 to $100, but these caps are harder to find than they used to be, so you need to do the math to figure out if a transfer is worth it (there are many online calculators to help you, including one at Bankrate.com). One note: Balance transfer offers have been phasing out since the start of the credit crunch, and some experts think they’ll soon be gone forever as a result of the CARD Act of 2009, which lays out new rules for credit card issuers. Keep tabs on this, and if you decide transferring will save you money, do it sooner rather than later. This route may not be cheaper than refinancing your debt as some sort of mortgage, but it’s definitely lower risk.
4. How do I deal with bill collectors?
A: The first rule of thumb in dealing with debt collectors: Know your rights. We’ve all heard the horror stories: threats of jail time, calls to employers or neighbors, the nonstop ringing of your phone. But for the most part, it’s a bad rap. True, there are a few companies out there that employ these scare tactics, but collection agencies are regulated by laws—both nationally (by the the federal Fair Debt Collection Practices Act) and at the state level.
These laws govern a number of issues. First, they specify how, when, and where debt collectors may contact you. The Federal Trade Commission (FTC) says that collectors can get in touch by phone, mail, or fax. They can call only between 8 AM and 9 PM. They can contact other people, such as friends, your boss, or relatives, only to find out where you live, what your phone number is, and where you work—not to discuss the debt or the amount of money you owe. They also must honor your request not to call you at work, so if that’s a problem, make the request in writing and send it to the collection agency by certified mail with a return reciept.
There are also regulations as to what the collectors are allowed to say. They aren’t allowed to threaten you, and if you’re told that you’ll go to jail or they’ll garnish your wages, they are crossing the line. Before they take any legal action against you, they’ll need to go to court, a lengthy and expensive process. You should report any inappropriate behavior to the FTC or your state attorney general’s office. (For a contact list of attorneys general, go to the National Association of Attorneys General at www.naag.org/attorneys_general.)
If a collection agency contacts you, the first thing you want to do is verify the debt. Doing so not only gives you time to make a plan but also provides you assurance that what they’re trying to collect is really a debt you incurred, in the exact amount you owe. Within 30 days of receiving a note or phone call about a debt, write a letter asking for more information about this debt, including how much you owe, to whom, when the debt originated, and what the interest rate is now. The collector should reply with these specifics in writing.
Once you receive this verification and have acknowledged that it is a debt that belongs to you, it’s time to negotiate. Debt collectors often pay as little as 5 to 10 cents on the dollar for your bad debts, depending on how recent they are. They don’t want to dedicate a lot of time getting the money, and they really don’t want to take the matter to court. That means you’re in a prime negotiating position. Explain that you want to make good but that you have other expenses to consider as well. Then offer them an amount that works with your budget but is still reasonable for the collector—it’s not always going to be the original amount owed. A good place to start is at 50% of the balance for a recent debt and 20% to 25% for a debt older than a few years. Then work up from there.
Once you’ve reached an agreement, make sure to get it in writing, and as a precaution, don’t allow collectors to take the money directly out of your bank account.
I Also Need to Know…
Q: How do I know if I am being contacted by an in-house collector (someone working for my creditor) versus a third-party debt collector? And should I treat them differently?
A: Collectors have to identify themselves by both their name and the name of the collection company or creditor whom they represent. There are generally three phases to the debt-collection process:
The major difference between dealing with your original creditor and dealing with an outside agency is that you need to ask for documentation of the debt from a collection agency in writing. Your creditor, of course, will have at least a few years’ worth of statements to prove how much you owe, but in some cases, collection agencies fail to prove their claims or even inflate balances (which is illegal). In general, the sooner you can settle the debt, the better, and that means working with your original creditor from the start.
Q: I was contacted by a debt-collection law firm. Does that mean I’m going to get sued?
A: Increasingly, creditors are turning over delinquent debts to debt-collection law firms instead of plain-vanilla bill collectors for this reason: A call or letter from a law firm sounds more official and so is often enough to scare consumers into paying up. But the truth is, whether the creditor takes you to court to get the money owed is still an economic decision based on the amount you’re delinquent, the cost of a trial, and whether a win on the creditor’s part is likely. Debt-collection law firms must abide by the Fair Debt Collection Practices Act, and in fact, are likely to comply. As attorneys, they stand to lose their ability to practice if they don’t. You should treat correspondence from a law firm the same way you would treat that from a collection agency.
Q: What if my debt is many years old?
A: You may have heard that paying on old debts is a mistake because it restarts the clock and forces you to pay when you shouldn’t have to or when you could have negotiated. But I believe that paying your debts—no matter how old or past due—is always a good idea, from both a moral and a financial standpoint. In general, blemishes stay on your credit report for seven years (and paying the debts won’t remove them), but each state has its own statute of limitations to dictate how long a debt collector has in which to sue you for the amount owed. These limitations vary from about 5 to 10 years. The clock starts when the debt first goes past due, so making a payment or negotiating a debt won’t turn back time. Just be sure to understand your state’s individual policy before you take any action.
Q: How do I get my credit back on track after a settlement?
A: Once you’ve reached an agreement, gotten it in writing, received confirmation that the debt is settled, and reported to the three major credit bureaus, you can start rebuilding your credit. It’s a process that takes time. Pay your bills on time every month. Pay down the amount you owe on your credit cards to 10% of your available credit if possible. Don’t cancel old cards, because that will reduce the amount of credit available to you, making your debt-to-credit—or utilization—ratio increase. And don’t shop around for credit you don’t need. Within 18 to 24 months, your credit should start to improve.
THE STATS
5. Which credit cards should I pay off first?
A: That depends what you’re trying to accomplish. Are you trying to get out of debt as quickly and cheaply as possible? Or are you trying to boost your credit score as quickly as possible?
If you’re trying to get out of debt as fast as you can, paying as little in interest to the credit card issuers, you should pay off the card with the highest interest rate first while paying the minimums on the rest. Once you’ve retired the debt on that card, move to the card with the second-highest interest rate, and so on. The reason this system works is that the return on your money is equal to the interest rate you’re paying. So if you’re paying off a 20% card, it’s like putting a 20%—guaranteed!—return in your pocket.
The second option is giving the cards with the lowest balances priority. Doing this has three benefits. First, crossing a card off your list is undoubtedly good for your mental health. It feels great and gives you more motivation to tackle the others. Second, it allows you to eliminate any annual fees attached to those cards. And third, if you’re looking to boost your credit score to qualify for a mortgage or auto loan in the near term, paying off low-balance cards can give your credit score a boost.
So the answer to your question depends on your end goal. But here’s an example so that you can see what the difference looks like in actual dollar terms.
An Example
John has five credit cards. He owes:
Total debt: $8,200
Option 1: Pay as much as you can afford on the card with the highest interest rate, while making just the minimums on the others.
Let’s say that John can afford to pay $350 a month total. Assuming his minimum monthly payments are calculated as 2.5% of each card’s balance, at the onset, $206 of that will go just toward meeting those. He can then start by putting the remaining $144 toward the first card, with the 29.9% interest rate. His end result:
Priority: Card 1 (29.9% APR)
Balance Original: $5,000
Total Interest Paid: $1,799.15
Months Until Paid Off: 26
Priority: Card 3 (27.9% APR)
Balance Original: $700
Total Interest Paid: $421.52
Months Until Paid Off: 28
Priority: Card 2 (24.9% APR)
Balance Original: $1,500
Total Interest Paid: $861.94
Months Until Paid Off: 32
Priority: Card 5 (11.9% APR)
Balance Original: $400
Total Interest Paid: $94.65
Months Until Paid Off: 33
Priority: Card 4 (7.9% APR)
Balance Original: $600
Total Interest Paid: $89.20
Months Until Paid Off: 33
APR = annual percentage rate.
Total interest Paid: $3,266.46
Option 2: Pay off the cards with the lowest balances first while making the minimums on the others.
Assuming John still has $350 to throw at his credit card debt each month and that the minimums on the cards are the same, he’s still left with $144 extra to go toward the card with the lowest balance, card 5 in the above calculation. Here’s how it shakes out:
Priority: Card 5 (11.9% APR)
Original Balance: $400
Total Interest Paid: $7.43
Months Until Paid Off: 3
Priority: Card 4 (7.9% APR)
Original Balance: $600
Total Interest Paid: $18.54
Months Until Paid Off: 7
Priority: Card 3 (27.9% APR)
Original Balance: $700
Total Interest Paid: $137.72
Months Until Paid Off: 10
Priority: Card 2 (24.9% APR)
Original Balance: $1,500
Total Interest Paid: $422.24
Months Until Paid Off: 17
Priority: Card 1 (29.9% APR)
Original Balance: $5,000
Total Interest Paid: $3,347.19
Months Until Paid Off: 35
APR = annual percentage rate.
Total interest paid: $3,933.12—a difference of about $666, or a big boost to your savings account.
I Also Need to Know…
Q: What if I can’t afford to pay on all of my debts?
A: You should prioritize, in this order:
Q: What happens if I fall behind on credit card payments?
A: Your phone will start ringing, and you’ll begin to receive letters from your creditors. The mistake a lot of people make is hiding from these communications. If you call and explain the situation—trust me, they have been hearing a lot of this since 2007—they may just help you out by halting the collection process or negotiating the terms with you so you pay less each month. If they won’t, and you continue not to pay, then in three to six months, your file will be turned over to a collection agency. For tips on handling bill collectors, see Chapter 1.
6. Is it safe to borrow from people whom you don’t know? I have visited Web sites featuring person-to-person lending, where individuals can get loans or give loans to complete strangers.
A: Most of these sites are only a few years old, and I expect to see more competition popping up in the near future. That’s not just because it has become harder to borrow money the traditional way, from banks and credit unions, because the credit market is so tight.
You need a solid credit score (720) to get some loans these days, and a stellar one (760 and higher) to get the best interest rates. You probably know how the traditional bank lending model works: Someone deposits a chunk of money in a certificate of deposit (CD) at a bank. Let’s say it’s a one-year term and the interest rate is 4%. The bank then lends that money to someone who needs a loan, charging that person a slightly higher interest rate, maybe 6%, 7%, or 8%. The difference in the interest rates is the bank’s profit. If you cut out the bank, forgo the CD, and lend your money to a borrower directly, you can keep the profit for yourself. That’s the person-to-person (P2P) lending model. Likewise, if you’re the borrower, you’ll pay a lower interest rate because the entire sum is going to your lender. Although the facilitator, typically a Web site such as Prosper.com or LendingClub.com, charges fees for both originating the loan and servicing it, there’s no middleman to take a cut. (For a look at the fees, see chart in Chapter 1.) It’s no surprise that P2P lending is becoming popular.
Is it safe? Well, that depends on the credibility of the Web site. The better sites will do much of the hard work for you, vetting everyone who agrees to make a loan the same way a bank or credit union would. The lender will need to provide a Social Security number and a bank account number to verify identity. The sites also pull the credit reports of potential borrowers and evaluate the risk involved with lending to that person. Most credible sites then assign a rating to each borrower, and it’s up to the lender to decide what rating he or she will require. Most sites also collect fees for late payments and report delinquencies to credit bureaus, so there’s no getting off the hook—you’ll need to adhere to the payment plan laid out for you by the site and your lender, just as you would if you were borrowing from a bank. Otherwise, your credit will suffer.
The downside? You may not be able to borrow the substantial sums of money you could from a bank, at least not from one lender. The typical size of a loan is less than $10,000 (Prosper.com’s year-to-date average loan amount as I was writing this was $6,047), so if you wanted to pull together, say, $25,000, you’d need to cobble together three or four loans. Because each loan has to be paid back separately, that can be a bit of an administrative hassle.
Bottom line: P2P lending is safe and quite likely the way of the future as long as you’ve vetted the site you use, verified that it’s secure, read all the fine print, and understand the terms of the loan.
I Also Need to Know…
Q: How do I verify that a P2P company or Web site is legitimate?
A: First stop: the Better Business Bureau (www.bbb.org/us/). If you visit the organization’s Web site, you can input the name of the business and its location, and a report will be generated listing the company’s contact information, its BBB rating, and any complaints. Keep in mind that when it comes to complaints, there are always two sides to every story, and the number of customers whom the company handles should be compared with the number of complaints received by the BBB. In other words, if a company counts millions of people in its customer base (think of the Amazon.coms of the world), 200 or so complaints shouldn’t be a deal-breaker. If they only have a few thousand customers and the same amount of griping, however, you might want to think twice.
If I’m satisfied with what the BBB listing turns up, I’ll often do an Internet search just to see what people are saying. Consumers love to share their experiences online, good and bad. Often, you can also turn up unbiased, credible newspaper or magazine articles, written by reporters who likely had to vet the company and spell out both the good and the bad.
After that, whenever money or personal information changes hands over the Internet, you always want to make sure the site is secure. The easiest way to do this is by identifying an https in the address bar at the beginning of the Web-site address, instead of the standard http. You should also look for a seal, generally toward the bottom of the Web page, that signifies that the site is secure. It often looks like a check mark.
Last—but this is very important—make sure the Web site lists contact information in the form of a working phone number, and call it to be sure you can get a real, live person on the line if necessary.
Q: Is this a good way to borrow money for college?
A: It certainly can be. A new company launched in 2008 specifically for this purpose, and it’s worth checking out: GreenNote (www.greennote.com). It focuses on community lending, allowing you to reach out to people you know, instead of strangers, to help finance your loan. One thing to keep in mind, though, is that you always want to max out your federal loan money before you start looking elsewhere. Federal money, such as a Stafford loan, almost always comes with a lower interest rate and better repayment terms than does money from other sources.
If you’re still short, then you can turn to P2P sites as an alternative to private student loans or carrying your tuition on a credit card or home equity loan. There are a few advantages here. Lending standards tend to be a bit more lenient with P2P, so a recent high school graduate with little or no credit history may not need a cosigner. P2P loans also tend to carry fixed interest rates. But you want to make sure that other terms are favorable as well, such as the repayment period, which may be shorter with a P2P loan.
Q: Do these sites charge fees?
A: They do. Borrowers, in general, will pay more than lenders. Here’s a comparison of the major players:
P2P SITE: Prosper
ELIGIBILITY: 520 FICO
LOAN TYPE: All
BORROWING LIMITS: $1,000–$25,000
FEES: Borrower pays a 2%–3% closing fee and late/ failed payment fees. Lender pays 1% annual servicing fee.
LOAN TERMS: Three years with fixed interest rate. Interest rate is negotiated between borrower and lender. No prepayment penalties.
P2P SITE: Lending Club
ELIGIBILITY: 640 FICO and debt-to-income ratio below 25%, excluding mortgage
LOAN TYPE: All
BORROWING LIMITS: $1,000–25,000
FEES: Borrower pays a pro cessing fee of 0.75%–3%. Lender pays 1% annual servicing fee.
LOAN TERMS: Three years with fixed interest rate. Interest rates range from 7.37% to 19.36%. No prepayment penalties.
P2P SITE: Loanio
ELIGIBILITY: A credit rating of E, as defined by the company, or a co-borrower
LOAN TYPE: All
BORROWING LIMITS: $1,000–$25,000
FEES: Borrower pays a one-time fee of 2%–3% (minimum $95). Lender pays annual servicing fee of 1%.
LOAN TERMS: Loans are available for 36, 48, or 60 months. Interest rates are negotiated between lenders and borrowers.
P2P SITE: GreenNote
ELIGIBILITY: Open to everyone
LOAN TYPE: Student
BORROWING LIMITS: $1,000–total cost of education
FEES: Borrower pays one-time fee of 2% (minimum $49). Lender pays 1%.
LOAN TERMS: Currently 6.8% fixed interest rate; six-month grace period after graduation; can defer payments for up to five years while in school; repay over 10 years; no prepayment penalties.
FICO score = Fair Isaac Corporation score, or your credit score; P2P = person-to-person (lending model).
Lender Contact Information
GreenNote
www.greennote.com
1-866-711-5620
Lending Club
www.lendingclub.com
1-866-754-4094
Loanio
www.loanio.com
1-800-624-8830
Prosper.com
www.prosper.com
1-866-615-6319
7. How do I know if I need credit counseling? What type of questions should I ask before signing on?
A: If you’ve gone over your budget carefully, if you’ve scraped together every penny, cut out every extra haircut, and started pulling overtime hours, and you still can’t make the minimum payments on all of your debt, it’s time to go see a credit counseling agency. Putting it off will only make things worse.
The right credit counselor will put you into a debt management plan (sometimes called a DMP) that will help you pay off your debts at lower interest rates. The counselor is essentially negotiating with your creditors to get you a break. How much of a break depends on the creditor, not you or the counselors—credit card companies have a schedule of interest-rate breaks they’re willing to give, and they won’t veer off that schedule. Late fees and other penalties are generally waived as well, which can be a huge relief and, if you’ve been delinquent for a long time, a huge savings.
But you’re not off the hook completely. In exchange for the reduction in what you owe, you’ll need to agree to stop using your credit cards and not to apply for additional credit. Once you do so and your program is set up, you’ll no longer make payments to your individual creditors. Instead, you’ll make one payment each month (generally by electronic debit) to the counseling agency, which will then distribute your money to creditors. You’ll pay both a monthly and an upfront fee to the agency.
So evaluate your financial situation and ask yourself a few questions: Are you taking out cash advances because you don’t have money in the bank? Are you using one credit card to pay another? Have you lost track of how much debt you have? Are you worrying about money on a daily basis?
If the answers are yes, you’ll likely benefit from credit counseling. But you can’t assume that every counseling agency that turns up on an Internet search is legitimate. Narrow your search to a few nearby (I would encourage you to go see a counselor in person rather than working exclusively over the phone) but then make sure that they are not-for-profit, recognized by the BBB (with no history of complaints), and a member of the National Foundation for Credit Counseling or the Independent Association of Certified Credit Counseling Agencies.
Questions to Ask a Credit Counselor (and the Answers You Want to Hear)
Q: What do you do?
A: Evaluate your financial situation to find a solution. Once we do that, the counselor will know whether your finances make you a good match for a DMP or whether you should be able to work through it alone with a bit of guidance. In about one-third of cases, a DMP may be insufficient, and you’ll need a bankruptcy attorney.
Red Flag: If the counselor says it will consolidate your debts or set you up with a DMP without asking for the specifics of your situation, move on.
Q: How much time will you spend on an initial consultation, and is there a charge?
A: A half hour or more. The initial consultation is always free.
Red Flag: It’s impossible to assess your situation in less than a half hour, so if counselors can’t commit to that, they won’t be very committed to helping you.
Q: What kind of debt do you help with?
A: All kinds. We also have a housing counselor on staff who can help you sort out your mortgage if need be.
Red Flag: Just credit cards. There’s no reason to go to a counselor who focuses solely on one area if other areas of your finances—mortgage, auto loan, student loans, medical debts—factor into the problem as well.
Q: How much will this cost?
A: Less than $75 upfront, with monthly payments on a sliding scale. You won’t pay more than $35 to $50 a month.
Red Flag: More than $75 to start and $50 a month is too much.
I Also Need to Know…
Q: How long does counseling take?
A: It generally will take three to five years to pay off all your debts and start fresh, depending on how much debt you have going in and how quickly you’re able to pay it off.
Q: Does everyone qualify for credit counseling?
A: No. If the counselor looks over your finances and concludes that the firm won’t be able to get you out of debt in three to five years, you won’t be admitted into the program. The level of debt that will push you into this area varies depending on your interest rates and income. If the firm won’t take you on, you’ll need to look into other options, such as debt settlement (see Chapter 1) or bankruptcy.
Q: Will credit counseling hurt my credit score?
A: There are a lot of misconceptions out there, but the truth is, credit counseling won’t hurt your credit score in the long run. It could show up on your credit report if you’re in a credit counseling program, but when you start the process, your credit is likely already trashed from months of late or missed payments and a high utilization ratio (which means you’re using too much of the credit available to you). Throughout the process, you’ll be able to bring your numbers up because the service will help you pay on time and lower the amount of debt that you’re carrying. In fact, when you emerge from debt, you may do so with a better score.
8. Do you have a script you use when asking credit card companies to lower their interest rates? What is that?
A: Cutting your interest rates can save you a huge amount of money each month, which can then be used to pay your cards down faster. And in good times and in bad, credit card companies are often willing to work with you. One study from U.S. Public Interest Research Group found that 50% of the time, calls asking for a reduction in interest rates were successful.
Recently, however, the advice has changed a bit. When you call to ask for an interest-rate reduction, the representative on the other end of the line is likely to be looking for clues into your financial situation, and reevaluating the risk the company is taking by extending you credit. That means that if you mention financial struggles, or a recent layoff, you might find your call met with an interest rate increase, not reduction. So you want to really stick to my advice and script, because otherwise, you may inadvertently set off the alarms. Here’s what I want you to do: Start by laying all your credit cards out in front of you in order of the interest rate (or annual percentage rate [APR]) that you’re paying on each, taking note of whether that rate is fixed or variable. Then, gather all of the preapproved cards you’ve received in the mail lately (admittedly, there aren’t as many as there once were, but I’ve still seen a few in my mailbox), and have a rough idea of your customer history with each card, including how long you’ve been a member, how much you charge each month or year, how much interest they’re earning from your business, and whether you pay on time.
Then pick up the phone and call the toll-free customer number on the back. The script comes in here.
Begin with:
I have [name of card] with you and my interest rate is [X] percent. I received another offer in the mail from [bank’s name] for [X] percent, but before I take it, I want to see if you’ll lower my interest rate instead.
If the representative says that he or she is not authorized to do that, you say:
Look, you and I both know that if I transfer my balance today, next week your bank is going to send me an offer to come back at an even lower rate. Why don’t you just save the bank the cost of that effort by giving me several points today?
If the rep says that’s not possible because your card is at a fixed rate, you say:
Actually, that doesn’t have anything to do with whether you have the ability to lower my interest rate. A fixed interest rate means only that my rate doesn’t vary with fluctuations in the prime rate. In fact, the bank can raise it on my account at any time by just giving me fifteen days’ written notice. And the bank can—if it chooses—lower the rate today.
If the rep still says that he or she is not authorized to do that, you say:
I’d like to speak to your supervisor.
Speak to a supervisor and go through the script again. Even if you get a substantial cut in the interest rate from the first person, it’s worth it to speak to a supervisor to see if you can do any better. The person on the front line of customer service will be authorized to cut your interest rate by only a preset amount, if at all. The customer service rep may also insist that the supervisor doesn’t have the power to cut your rate either, or—if you’ve already gotten a break—to cut it further. That may not be true, so insist on speaking to the supervisor anyway.
Other tricks:
THE MATH
Knocking your interest rate down just a couple of points can have a big impact. How?
Card 1
Balance: $20,000
Interest rate: 18%
Amount you can pay: $500 per month
Payoff time: 5 years
Total interest paid: $11,000
Card 2
Balance: $20,000
Interest rate: 14%
Amount you can pay: $500 per month
Payoff time: 4½ years
Total interest paid: $7,000
Savings: $4,000
I Also Need to Know…
Q: What should I consider before doing a balance transfer?
A: A few things:
Q: Are “preapproved” offers legit?
A: Sometimes, but as always, you have to read the entire offer, top to bottom and front to back. Get out your magnifying glass if you have to (and you might). The mailing may say you’re “preapproved” for a particular card, but the lucrative interest rate in bold print may not be the one you receive. Chances are, the company is using tiered pricing, meaning it offers a range of interest rates depending on your credit history. The advertised rate is generally the lowest of the low, and if you have stellar credit, you just might get it. But if you don’t, you’ll likely end up with a higher rate.
Q: What is the Credit CARD Act of 2009?
A: The Credit CARD Act of 2009—officially named the Credit Card Accountability Responsibility and Disclosure Act of 2009—was signed into law by President Obama in May 2009. The Act provides new consumer protections when it comes to credit cards, most of which go into effect in February of 2010. Here are the big changes:
Q: Aside from lowering my interest rate, are there other ways to pay off my credit card debt quickly?
A: The best way is paying more than the minimum each month. Paying just the minimum—which is usually 2% to 3% of the total—puts you on a slow road to a zero balance. That’s because while you’re paying 2% of your balance each month, the bank is charging you 6, 7, 8, even 10 times that much in interest. At that rate, your bill is going up each month, not down.
Just scraping together a few extra dollars a week to put toward your debt can drastically reduce not only the time it takes you to pay it off but also the amount you pay the bank in interest. Look at it this way: Each month, you probably have at least two or three things you buy that you don’t need. Most of us have more. I’m talking about everything from a coffee or a sandwich to splurges such as a new pair of shoes or a handful of songs on iTunes. Just taking that money and putting it toward your debt can do a world of good.
An Example
Take a card with a 13% APR and a $4,000 balance. Pay only the minimum each month, and you’ll be in debt for the next 13 years and 7 months. You’ll also pay more than $2,500 in interest.
On the flip side, if you can add an extra $50 a month to your payments—that’s about seven sandwiches, dinner for two, or your coffee bill if you hit Starbucks every morning—you’ll shave nearly 11 years off the life of your debt and you’ll save almost $2,000 in interest.
Q: Does lowering my interest rate affect my credit score?
A: The decreased interest rate doesn’t actually affect your score, because interest rates aren’t reflected in your credit report. But the actual act of requesting a lower interest could ding your score slightly. That’s because when you ask your company to change your interest rate or balance limit, it’s technically considered an application for credit, and in many cases, the company will pull your credit history before making a decision. So you have to weigh your options. If you’re a person who rarely shops for credit, one inquiry isn’t going to be catastrophic. But if you tend to open new accounts often or you think you might apply for a mortgage or other major loan in the next year or so, you might want to pass on this strategy.
One other suggestion: If you can handle an increased credit limit (meaning you won’t use it as an excuse to spend more), you might consider asking for one in conjunction with the interest-rate reduction. That’s because an increased credit limit helps your credit score, which might have the effect of evening things out.
9. What is the difference between chapter 13, chapter 11, and chapter 7 bankruptcy? How do I know which one to file?
A: The average consumer considering bankruptcy only needs to choose between chapter 13 and chapter 7. Chapter 11 is primarily for debtors who own a business and want to be able to file bankruptcy without putting that business at risk. Also, filing chapter 11 is expensive—you’ll pay a $1,000 filing fee and a $39 miscellaneous administrative fee, not to mention hefty bills for lawyers.
That said, when it comes to putting chapter 13 up against chapter 7, here’s what you need to know:
Chapter 7 bankruptcy is a liquidation plan. To file for chapter 7 bankruptcy, your monthly income must be less than or equal to the median income for a household of your size in your state (you can find this on www.census.gov). If it is, you can file for chapter 7, which allows you to liquidate old debts and start from scratch. You’ll lose some, but not all, of your property. Each state has laws that allow you to keep certain things, typically part of the equity in your residence, necessary clothing within reason, a few hundred dollars worth of jewelry, and pensions. The charge for chapter 7 is currently $245 for filing fees and about $54 in administrative fees and trustee surcharges.
Chapter 13 bankruptcy is a repayment plan rather than a liquidation plan. It’s often called a wage earner’s plan because it allows individuals with a regular income to develop a plan to repay all or part of their debts. Basically, you’ll propose a repayment plan to make installment payments to your creditors over three to five years. The plan then has to be approved in bankruptcy court, and if it is, you’ll be able to reschedule secured debts—such as car loans—and extend them to lower your payments and make them more manageable. Any remaining disposable income must then go toward unsecured debts (credit card or medical bills). In most cases, you don’t have to pay these debts off in full, but any extra money you have will need to go toward them.
The charge to file chapter 13 is a $235 filing fee and the standard $39 for administrative costs.
Keep in mind that in most cases, courts will allow you to pay the fees associated with filing for bankruptcy in installments. But you’ll also need to take legal fees into consideration, which can range from about $1,200 to $1,400 for chapter 7 and upward of $3,000 for chapter 13.
Finally—and this is important—the Bankruptcy Reform Act of 2005 requires that you go through credit counseling before filing. A good not-for-profit credit counselor (see Chapter 1) will help you figure out if bankruptcy is the best option for you, because it’s certainly not something you want to take lightly. It may be that you can use a debt management program (DMP) through the credit counseling service to get back on track without having to file bankruptcy. Over the long term, a DMP will be better for both your credit score and your assets.
THE MATH
How does extending an auto loan (as you may be able to do through chapter 13 bankruptcy) change your monthly payments?
Original auto loan:
Amount: $15,000
Term: 4 years
Interest rate: 6.6%
Monthly payment: $356
Auto loan modified in bankruptcy:
Amount: $15,000
Term: 6 years
Interest rate: 6.6%
Monthly payment: $252
Reduction in monthly payment: $104 a month
Additional interest cost over the life of the loan: $1,100
I Also Need to Know…
Q: How long does it take to redeem my credit after filing for bankruptcy?
A: Not as long as you think. Bankruptcy is, of course, a big black mark on your credit history, and it will stay on your file for 7½ years. But if you come out of bankruptcy determined to stay on track—and follow through—you’ll likely start receiving credit card offers in the mail within about two years. Boost your chances by making your bill payments on time, keeping your debt low, and not shopping around for credit. You also might consider getting a secured card in the interim. A secured card looks just like a credit card, but you have to make an initial deposit that then becomes your credit limit. Most cards will automatically convert to traditional credit cards after about 18 months of good behavior on your part.
Q: How can I find a good bankruptcy attorney? Do I need one or can I go it alone?
A: You probably do need one, but do a little research first. About 80% of people who file bankruptcy do it with the help of an attorney, and the reason for this is simple: Bankruptcy laws are complicated, and a misstep can cost you. But before you hire someone, head to the library and read a couple of books on the subject. If your situation is fairly simple—say you qualify for chapter 7 and just have a few credit cards—and you feel comfortable navigating the system on your own, then you have the option to do that. But in most cases, you’re going to want an attorney because things can get overwhelming—fast.
To find a bankruptcy lawyer, do so the same way you’d look for a doctor. If you know any people who have filed for bankruptcy, ask them if they used an attorney and whether they’d recommend him or her. If that doesn’t work, you can do a search for attorneys in your area through the National Association of Consumer Bankruptcy Attorneys or Nolo.com, or ask your personal lawyer for a referral. Any good lawyer will grant you an initial meeting free of charge, so you can ask any questions you might have and get an idea of the overall cost before you sign on. You do want to make sure that the attorney specializes in bankruptcy, of course.
Resources
Associations
The Association of Credit and Collection Professionals
www.acainternational.org
952-926-6547
This trade association for professional businesses and individuals in the credit and collection industry provides consumers with credit and collection resources, including educational materials, answers to frequently asked questions (FAQs) about debt collection, and explanations of your rights as a consumer.
The Association of Settlement Companies (TASC)
www.tascsite.org
1-888-657-8272
TASC promotes good business practices in the debt settlement industry to protect both consumers and debt settlement companies. Search for TASC-accredited debt settlement companies by name or state.
National Association of Consumer Bankruptcy Attorneys
www.nacba.org
The Web site for this association of consumer bankruptcy attorneys features consumer tips and links to bankruptcy news.
National Association of Consumer Advocates
www.naca.net
202-452-1989
A nationwide organization of attorneys who represent consumers who have been victimized by debt-collection abuse.
National Foundation for Credit Counseling
www.nfcc.org
301-589-5600
The national voice for credit counseling agencies, the foundation is composed of more than 100 member agencies and 900 local offices throughout the United States; search for a member agency, access free debt advice, and more.
The United States Organizations for Bankruptcy Alternatives (USOBA)
www.usoba.org
281-820-0666
USOBA represents the debt-negotiation industry by creating specific agendas for states and advocating fair regulation and protection for consumers. Access answers to FAQ for consumers about settling debts and subscribe to a free monthly newsletter with money-saving tips.
Books
Chapter 13 Bankruptcy: Keep Your Property and Repay Debts Over Time, by Stephen Elias and Robin Leonard (2008).
A well-written, plain-English look at chapter 13 from the folks at Nolo.com.
The Complete Guide to Prosper.com: How to Borrow and Lend Money Online, by Sean Bauer (2008).
A detailed guide on how to use Prosper.com, including tips and resources for the user.
How to Get Credit Counseling, by Quick Easy Guides (2008).
A simple guide with tips and trade secrets for seeking professional help with your credit card debt.
How You Can Profit from Credit Cards: Using Credit to Improve Your Financial Life and Bottom Line, by Curtis E. Arnold (2008).
Insight into how you can benefit from credit card usage and also tips to mitigate your debt and cut back on your cost of credit.
National Consumer Law Center Guide to Surviving Debt, by Deanne Loonin (2008).
A concise, specific guide to managing debt in different stages and situations, which takes current laws and regulations into account to provide consumers with the most up-to-date information on how to handle debt while legally protecting themselves.
Pay It Down! Debt Free on $10 a Day, by Jean Chatzky (2009).
Strategies for finding $10 a day and moving toward financial security.
Stop Debt Collectors, by Gerri Detweiler, Mary Reed, and John Ventura (2008).
A practical guide on how to deal with debt collectors and protect your rights in the process.
You’re Nothing but a Number: Why Achieving Great Credit Scores Should be on Your List of Wealth Building Strategies, by John Ulzheimer (2007).
Learn how to build and keep a great credit score; book includes information on the inner workings of the credit card system and companies.
Government Agencies
Federal Trade Commission
www.ftc.gov
1-877-FTC-HELP (1-877-382-4357)
An independent government agency whose mission is to protect consumers and eliminate anticompetitive business practices. On their site you will find information about debt settlement, opportunities to attend workshops, facts about negotiating debt and debt collection (including the complete text of the Fair Debt Collection Practices Act), information on debt consolidation and alternative methods to shrink the size of your debt, several detailed guides with information on how to repay credit card debt, and information on your rights as a consumer regarding credit.
United States bankruptcy courts
www.uscourts.gov/bankruptcycourts.html
This section of the U.S. courts’ Web site offers bankruptcy forms, as well as information about how to file and what chapter is best for your situation.
Web sites
American Bankruptcy Institute Consumer Bankruptcy Center
consumer.abiworld.org
703-739-0800
The American Bankruptcy Institute is the nation’s largest multi-disciplinary, nonpartisan organization dedicated to the researching of and educating others about bankruptcy.
AnnualCreditReport.com
www.annualcreditreport.com
Request a free copy of your credit report once a year from each of the nationwide consumer credit reporting companies.
BankRate.com
www.bankrate.com
561-630-2400
Get news and advice on credit cards, use a credit card repayment calculator, compare interest rates on mortgages and home equity loans nationwide, compare credit card rates, find the best cards for balance transfers, and more.
Credit.com
www.credit.com
Advice and tools for getting out of debt; articles specific to debt settlement; a comparison chart of debt-help products and services; tips on how to negotiate credit card debt; a credit score compass, which navigates you to an estimate of your credit score; advice on credit card balance transfers; and comparisons of cards by criteria such as interest rates and whether they allow balance transfers.
HSH Associates
www.hsh.com
1-800-873-2837
HSH has up-to-date information about interest rates on mortgages, refinances, and home equity loans, so you can find the best deals in your area.
National Consumer Law Center (NCLC)
www.consumerlaw.org
202-452-6252
A national consumer law expert, NCLC works to combat unfair business practices by collection agencies.
Nolo
www.nolo.com
1-800-728-3555
Nolo is a legal information site. It has answers to FAQs and articles about bankruptcy, estate planning, real estate, and other money matters. You can also use the site’s attorney search feature to find a lawyer in your area.