NYT: Weighing the Options With Credit Card Debt

By TARA SIEGEL BERNARD

Many consumers are buckling under the weight of mounting credit card debt.

So it should come as no surprise that some have been lured in by often-hollow promises from debt settlement companies, claiming they can reduce debts to a small fraction of what is owed by negotiating with creditors.

But as their customers have learned, debt settlement companies are not debt genies — they do not have special powers to make your debt disappear. Andrew M. Cuomo, New York State’s attorney general, recently announced an investigation into more than a dozen debt settlement companies. Many companies require hefty upfront fees — often 15 percent of your total debt — but often don’t deliver on their promises, experts say.

Of course, figuring out a reasonable way to shed debt may seem an insurmountable task, especially if you have lost your job or you are simply not earning enough. The numbers are not pretty: if you carry $10,000 on a credit card with an 18 percent rate and make only the minimum payment (say, 1 percent of the balance plus interest), it will take 32 years to pay it off — for a grand total of $24,834. That does not count late fees or over-the-limit charges.

So it is important to assess your options before you fall too far behind. This is probably best accomplished with a reputable credit counselor. But before you pick up the phone, familiarize yourself with the pros and cons of the various options.

DO IT YOURSELF If you have only a few thousand dollars in debt on one or two cards, you may try calling your card issuer and asking it about any repayment plan for people facing financial hardship. The company may be willing to work with you. But keep in mind that it is likely to reduce your credit limits to your current balance, experts said.

“Most people are very hesitant to call their creditors,” said Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling. “But they are the first ones they should consult. They have programs for short-term financial hiccups.”

FIND A COUNSELOR If you are knee-deep in debt, or your debt is spread across multiple cards, consult with a financial counselor. A credit counselor can assess your entire financial picture and help determine the best course of action. It may be as simple as setting up a payment plan that you can handle on your own.

But you need to be careful when choosing a counselor. Stick with someone who is affiliated with one of the legitimate, nonprofit umbrella organizations like the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies. Their fees should be reasonable (about $30 to $50 to set up, say, a debt management plan) and they should not turn you away if you cannot afford the nominal fee. They should also be willing to spend an hour with you, at the least.

DEBT MANAGEMENT PLAN A credit counseling agency should be able to determine whether this type of plan will work for you. Here is how they operate: the agency negotiates a lower interest rate and payment with the card companies, to a level you can afford. All late fees and over-the-limit fees stop. You then make a single payment to your counseling agency, which disburses the payment to all your creditors. The agency usually charges a fee of about $25 a month. Most plans last three to five years, at which point your existing debt will be paid off.

“A debt management plan doesn’t reduce the balance, but one of the big advantages is that the interest rates go down, usually significantly,” said Rick Phillips, vice president of debt management plan services at Consumer Credit Counseling Service of Greater Atlanta. He said most people who came to them were paying rates from 25 to 29 percent, which usually drop to 6 to 12 percent, or lower.

But these days, fewer people can afford traditional debt management plans. As a result, two credit counseling groups struck a deal with the top 10 credit card issuers this month to make the debt management plans more affordable. That may include lowering the minimum payment and the interest rate even further.

Participating in these plans will not necessarily hurt your credit score, but it is a gray area. It depends on how your creditor reports it to the credit rating agencies. Still, digging out of debt should be the priority; your credit score will eventually improve. Missing payments remain on your record for seven years.

DEBT SETTLEMENT So should debt settlement companies be avoided at all costs? They certainly should not be your first call.

“Sometimes, there are no good solutions, but of the solutions, debt settlement ends up being their best bet,” Gerri Detweiler, a credit adviser at Credit.com, said. “There is a segment of people who cannot afford to pay the full amount through a debt management, but they either don’t want to file for bankruptcy or they can’t file for bankruptcy.” (Credit.com refers prescreened consumers to debt settlement companies through its Web site; the settlement company pays Credit.com a fee each time a consumer fills out an application. Credit.com vets the companies to be sure they disclose all costs.)

But consumer advocates said that many people ended up dropping out of these plans because of the high fees. When you sign up, many firms require you to pay a sizable fee upfront. Or they may levy initial set-up and monthly fees, and charge a percentage of the amount they saved you. They typically advise you to stop paying your debts and tell you to put aside money each month in a separate account over a period of two or three years. That sum will eventually be used to negotiate a settlement, usually about 60 percent of what you owe. In the meantime, though, credit card companies continue to charge interest and late fees. The creditor may sue. And the phone will probably continue to ring incessantly. The companies can offer no guarantees — except that your credit score will drop.

“I wouldn’t rule out the possibility that there is a good company out there, but the basic business model is not a good one for consumers,” said Deanne Loonin, a lawyer at the National Consumer Law Center who has researched the companies. “A lot of creditors won’t even work with debt settlement companies.”

And here is another little-known fact: Any debt forgiven exceeding $600 is considered taxable income unless you can prove you are insolvent (your liabilities exceed your assets).

BANKRUPTCY For some people, at least, it pays to visit a bankruptcy lawyer, where the initial consultations should be free. A lawyer can advise you of your rights and walk you through the many implications of bankruptcy. “It’s not a bad idea if you’re under a lot of financial stress or you are afraid of losing your assets,” Ms. Detweiler said. It also pays to meet with a bankruptcy lawyer and a credit counselor before you consider debt settlement. “If you do it the other way around, you are very vulnerable to being led down the wrong path,” she said. “And what I find is that people hear what they want to hear.”

Copyright 2009 The New York Times Company. All rights reserved.