By PETER S. GOODMAN
PALM BEACH, Fla. — For the companies that promise relief to Americans confronting swelling credit card balances, these are days of lucrative opportunity.
So lucrative, that an industry trade association, the United States Organizations for Bankruptcy Alternatives, recently convened here, in the oceanfront confines of the Four Seasons Resort, to forge deals and plot strategy.
At a well-lubricated evening reception, a steel drum band played Bob Marley songs as hostesses in skimpy dresses draped leis around the necks of arriving entrepreneurs, some with deep tans.
The debt settlement industry can afford some extravagance. The long recession has delivered an abundance of customers — debt-saturated Americans, suffering lost jobs and income, sliding toward bankruptcy. The settlement companies typically harvest fees reaching 15 to 20 percent of the credit card balances carried by their customers, and they tend to collect upfront, regardless of whether a customer’s debt is actually reduced.
State attorneys general from New York to California and consumer watchdogs like the Better Business Bureau say the industry’s proceeds come at the direct expense of financially troubled Americans who are being fleeced of their last dollars with dubious promises.
Consumers rarely emerge from debt settlement programs with their credit card balances eliminated, these critics say, and many wind up worse off, with severely damaged credit, ceaseless threats from collection agents and lawsuits from creditors.
In the Kansas City area, Linda Robertson, 58, rues the day she bought the pitch from a debt settlement company advertising on the radio, promising to spare her from bankruptcy and eliminate her debts. She wound up sending nearly $4,000 into a special account established under the company’s guidance before a credit card company sued her, prompting her to drop out of the program.
By then, her account had only $1,470 remaining: The debt settlement company had collected the rest in fees. She is now filing for bankruptcy.
“They take advantage of vulnerable people,” she said. “When you’re desperate and you’re trying to get out of debt, they take advantage of you.” Debt settlement has swollen to some 2,000 firms, from a niche of perhaps a dozen companies a decade ago, according to trade associations and the Federal Trade Commission, which is completing new rules aimed at curbing abuses within the industry.
Last year, within the industry’s two leading trade associations — the United States Organizations for Bankruptcy Alternatives and the Association of Settlement Companies — some 250 companies collectively had more than 425,000 customers, who had enrolled roughly $11.7 billion in credit card balances in their programs.
As the industry has grown, so have allegations of unfair practices. Since 2004, at least 21 states have brought at least 128 enforcement actions against debt relief companies, according to the National Association of Attorneys General. Consumer complaints received by states more than doubled between 2007 and 2009, according to comments filed with the Federal Trade Commission.
“The industry’s not legitimate,” said Norman Googel, assistant attorney general in West Virginia, which has prosecuted debt settlement companies. “They’re targeting a group of people who are already drowning in debt. We’re talking about middle-class and lower middle-class people who had incomes, but they were using credit cards to survive.”
The industry counters that a few rogue operators have unfairly tarnished the reputations of well-intentioned debt settlement companies that provide a crucial service: liberating Americans from impossible credit card burdens.
With the unemployment rate near double digits and 6.7 million people out of work for six months or longer, many have relied on credit cards. By the middle of last year, 6.5 percent of all accounts were at least 30 days past due, up from less than 4 percent in 2005, according to Moody’s Economy.com.
Yet a 2005 alteration spurred by the financial industry made it harder for Americans to discharge credit card debts through bankruptcy, generating demand for alternatives like debt settlement.
The Arrangement
The industry casts itself as a victim of a smear campaign orchestrated by the giant banks that dominate the credit card trade and aim to hang on to the spoils: interest rates of 20 percent or more and exorbitant late fees.
“We’re the little guys in this,” said John Ansbach, the chief lobbyist for the United States Organizations for Bankruptcy Alternatives, better known as Usoba (pronounced you-SO-buh). “We exist to advocate for consumers. Two and a half billion dollars of unsecured debt has been settled by this industry, so how can you take the position that it has no value?”
But consumer watchdogs and state authorities argue that debt settlement companies generally fail to deliver.
In the typical arrangement, the companies direct consumers to set up special accounts and stock them with monthly deposits while skipping their credit card payments. Once balances reach sufficient size, negotiators strike lump-sum settlements with credit card companies that can cut debts in half. The programs generally last two to three years.
“What they don’t tell their customers is when you stop sending the money, creditors get angry,” said Andrew G. Pizor, a staff lawyer at the National Consumer Law Center. “Collection agents call. Sometimes they sue. People think they’re settling their problems and getting some relief, and lo and behold they get slammed with a lawsuit.”
In the case of two debt settlement companies sued last year by New York State, the attorney general alleged that no more than 1 percent of customers gained the services promised by marketers. A Colorado investigation came to a similar conclusion.
The industry’s own figures show that clients typically fail to secure relief. In a survey of its members, the Association of Settlement Companies found that three years after enrolling, only 34 percent of customers had either completed programs or were still saving for settlements.
“The industry is designed almost as a Ponzi scheme,” said Scott Johnson, chief executive of US Debt Resolve, a debt settlement company based in Dallas, which he portrays as a rare island of integrity in a sea of shady competitors. “Consumers come into these programs and pay thousands of dollars and then nothing happens. What they constantly have to have is more consumers coming into the program to come up with the money for more marketing.”
The Pitch
Linda Robertson knew nothing about the industry she was about to encounter when she picked up the phone at her Missouri home in February 2009 in response to a radio ad.
What she knew was that she could no longer manage even the monthly payments on her roughly $23,000 in credit card debt.
So much had come apart so quickly.
Before the recession, Ms. Robertson had been living in Phoenix, earning as much as $8,000 a month as a real estate appraiser. In 2005, she paid $185,000 for a three-bedroom house with a swimming pool and a yard dotted with hibiscus.
When the real estate business collapsed, she gave up her house to foreclosure and moved in with her son. She got a job as a waitress, earning enough to hang on to her car. She tapped credit cards to pay for gasoline and groceries.
By late 2007, she and her son could no longer afford his apartment. She moved home to Kansas City, where an aunt offered a room. She took a job on the night shift at a factory that makes plastic lids for packaged potato chips, earning $11.15 an hour.
Still, her credit card balances swelled.
The radio ad offered the services of a company based in Dallas with a soothing name: Financial Freedom of America. It cast itself as an antidote to the breakdown of middle-class life.
“We negotiate the past while you navigate the future,” read a caption on its Web site, next to a photo of a young woman nose-kissing an adorable boy. “The American Dream. It was never about bailouts or foreclosures. It was always about American values like hard work, ingenuity and looking out for your neighbor.”
When Ms. Robertson called, a customer service representative laid out a plan. Every month, Ms. Robertson would send $427.93 into a new account. Three years later, she would be debt-free. The representative told her the company would take $100 a month as an administrative fee, she recalled. His tone was take-charge.
“You talk about a rush-through,” Ms. Robertson said. “I didn’t even get to read the contract. It was all done. I had to sign it on the computer while he was on the phone. Then he called me back in 10 minutes to say it was done. He made me feel like this was the answer to my problems and I wasn’t going to have to face bankruptcy.”
Ms. Robertson made nine payments, according to Financial Freedom. Late last year, a sheriff’s deputy arrived at her door with court papers: One of her creditors, Capital One, had filed suit to collect roughly $5,000.
Panicked, she called Financial Freedom to seek guidance. “They said, ‘Oh, we don’t have any control over that, and you don’t have enough money in your account for us to settle with them,’ ” she recalled.
Her account held only $1,470, the representative explained, though she had by then deposited more than $3,700. Financial Freedom had taken the rest for its administrative fees, the company confirmed.
Financial Freedom later negotiated for her to make $100 monthly payments toward satisfying her debt to the creditor, but Ms. Robertson rejected that arrangement, no longer trusting the company. She demanded her money back.
She also filed a report with the Better Business Bureau in Dallas, adding to a stack of more than 100 consumer complaints lodged against the company. The bureau gives the company a failing grade of F.
Ms. Robertson received $1,470 back through the closure of her account, and then $1,120 — half the fees that Financial Freedom collected. Her pending bankruptcy has cost her $1,500 in legal fees.
“I trusted them,” she said. “They sounded like they were going to help me out. It’s a rip-off.”
Financial Freedom’s chief executive, Corey Butcher, rejected that characterization.
“We talked to her multiple times and verified the full details,” he said, adding that his company puts every client through a verification process to validate that they understand the risks — from lawsuits to garnished wages.
Intense and brooding, Mr. Butcher speaks of a personal mission to extricate consumers from credit card debt. But roughly half his customers fail to complete the program, he complained, with most of the cancellations coming within the first six months. He pinned the low completion rate on the same lack of discipline that has fostered many American ailments, from obesity to the foreclosure crisis.
“It comes from a lack of commitment,” Mr. Butcher said. “It’s like going and hiring a personal trainer at a health club. Some people act like they have lost the weight already, when actually they have to go to the gym three days a week, use the treadmill, cut back on their eating. They have to stick with it. At some point, the client has to take responsibility for their circumstance.”
Consumer watchdogs point to another reason customers wind up confused and upset: bogus marketing promises.
In April, the United States Government Accountability Office released a report drawing on undercover agents who posed as prospective customers at 20 debt settlement companies. According to the report, 17 of the 20 firms advised clients to stop paying their credit card bills. Some companies marketed their programs as if they had the imprimatur of the federal government, with one advertising itself as a “national debt relief stimulus plan.” Several claimed that 85 to 100 percent of their customers completed their programs.
“The vast majority of companies provided fraudulent and deceptive information,” said Gregory D. Kutz, managing director of forensic audits and special investigations at the G.A.O. in testimony before the Senate Commerce Committee during an April hearing.
At the same hearing, Senator Claire McCaskill, a Missouri Democrat, pressed Mr. Ansbach, the Usoba lobbyist, to explain why his organization refused to disclose its membership.
“The leadership in our trade group candidly was concerned that publishing a list of members ended up being a subpoena list,” Mr. Ansbach said.
“Probably a genuine concern,” Senator McCaskill replied.
The Coming Crackdown
On multiple fronts, state and federal authorities are now taking aim at the industry.
The Federal Trade Commission has proposed banning upfront fees, bringing vociferous lobbying from industry groups. The commission is expected to issue new rules this summer. Senator McCaskill has joined with fellow Democrat Charles E. Schumer of New York to sponsor a bill that would cap fees charged by debt settlement companies at 5 percent of the savings recouped by their customers. Legislation in several states, including New York, California and Illinois, would also cap fees. A new consumer protection agency created as part of the financial regulatory reform bill in Congress could further constrain the industry.
The prospect of regulation hung palpably over the trade show at this Atlantic-side resort, tempering the orchid-adorned buffet tables and poolside cocktails with a note of foreboding.
“The current debt settlement business model is going to die,” declared Jeffrey S. Tenenbaum, a lawyer in the Washington firm Venable, addressing a packed ballroom. “The only question is who the executioner is going to be.”
That warning did not dislodge the spirit of expansion. Exhibitors paid as much as $4,500 for display space to showcase their wares — software to manage accounts, marketing expertise, call centers — to attendees who came for two days of strategy sessions and networking.
Cody Krebs, a senior account executive from Southern California, manned a booth for LowerMyBills.com, whose Internet ads link customers to debt settlement companies. Like many who have entered the industry, he previously sold subprime mortgages. When that business collapsed, he found refuge selling new products to the same set of customers — people with poor credit.
“It’s been tremendous,” he said. “Business has tripled in the last year and a half.”
The threat of regulations makes securing new customers imperative now, before new rules can take effect, said Matthew G. Hearn, whose firm, Mstars of Minneapolis, trains debt settlement sales staffs. “Do what you have to do to get the deals on the board,” he said, pacing excitedly in front of a podium.
And if some debt settlement companies have gained an unsavory reputation, he added, make that a marketing opportunity.
“We aren’t like them,” Mr. Hearn said. “You need to constantly pitch that. ‘We aren’t bad actors. It’s the ones out there that are.’ ”
Copyright 2010 The New York Times Company. All rights reserved.
Monday, June 21, 2010
Thursday, June 10, 2010
John Tesh: Your score? And...what's your score again?
Confused about your score? Your credit score, that is? You're not alone. Many of us are in the dark about these scores that seem to have a large impact on us- our ability to get credit, to buy a car or a house- even our jobs! Credit score
Liz Pulliam Weston, a favorite of ours who puts the common sense to our cents, is here to tell us that the end of these dark ages about our credit scores may be coming to an end.
Free access to your credit scores may be just around the corner. The financial-reform bill recently passed in the Senate passed includes an amendment that would give individuals the right to see their scores if those numbers were used against them in a financial transaction.
In other words, if you were denied a mortgage or insurance, or had to pay more for either one because of your credit, you'd get to see the score that was used to make the decision.
This is a big deal, according to Weston. We've been able to see our credit reports- a history of what we've borrowed and how well we've repaid it- for free since 2003, but the three-digit scores calculated from those reports have continued to carry a price tag.
Consumer advocates, like Weston, have been pushing Congress to give people free access to their scores. But some proposals were mushy on the issue of which scores consumers would get to see.
Knowing the scores
Not all credit scores are created equal, and the credit bureaus are famous for selling consumers "educational" scores that aren't widely used by lenders. And there are many variations of the FICO score, including versions tailored to auto, credit card, installment loan and finance companies that are rarely seen.
"There was a question whether they would wind up with a score that isn't the same one used by the lender or the insurance company," said credit expert John Ulzheimer, who writes for Credit.com and who advised Sen. Mark Udall, D-Colo., in drafting this amendment. Under the amendment language, "you have a right to see the report and the score that was used. It's a transactional score versus an educational score."
Weston acknowledges that this amendment falls short of the full disclosure she has long wanted to see, which would be to ensure all consumers had free access to their FICOs, the credit scores used by most lenders. (Free FICOs, by the way, is a concept supported by Fair Isaac, the company that created the FICO scoring formula, and vigorously opposed by the credit bureaus that want to sell you those other scores.)
What you could expect to see
But this financial-services amendment is a better deal in some ways. If the amendment becomes law- it still has to survive the reconciliation process, in which the Senate's reform bill is merged with the one passed by the House- it will expand dramatically the universe of relevant scores to which you'll have access if your scores cause you a problem.
"In the past, scores like the FICO auto version have been like a unicorn. People talked about it all the time, but nobody had actually ever seen it," Ulzheimer says. "Now you'll get to see the unicorn."
The world of insurance scores is even more diverse. No one formula dominates this industry, as FICO does lending, and many of the largest insurers have their own proprietary scores. Seeing these numbers could start to peel back the mystery of insurance scoring, just as access to FICO scores a decade ago started cracking open the credit-scoring vault. As more people learned their FICOs and how important they were, the pressure mounted for the score's creators to disclose more about how they worked, and today we know far more about the inner machinery.
Another point about the amendment is that it would cut out the credit bureaus, the companies that have made getting your free annual credit reports so confusing in the first place..
The bureaus that run the federally mandated site, AnnualCreditReport.com (the ONLY site giving you completely free credit reports one time per year), hammer consumers with advertisements trying to encourage the purchase of credit scores and credit monitoring, when, in fact, you're just trying to get your free reports.
And some operate look-alike sites that appear to cash in on consumer confusion about where to get free reports.
Rather than giving bureaus another opportunity to profit on your financial information and confuse you in the process, the amendment would put the responsibili Credit report ty on the insurer or lender that was evaluating you. These companies are already required to send you a notice that provides free access to the credit report used in making an "adverse action," or decision, against you. The amendment would add the requirement that you be supplied with the score used.
A little less than advertised
There's one area where the amendment's promoters have tripped a bit, and that's in touting this as helpful to people who are looking for work. The wording says people would have a right to a score if the information in their credit reports was used against them, but employers don't look at scores- they typically look only at credit reports, so no scores would be generated in those cases. Using credit to discriminate in employment is a hot issue- as Weston has written about before- but this amendment wouldn't fix that problem.
Other than that, this could be a monumentally big win for consumers, and that's always a step in the right direction!
John
Copyright 2010 Tesh Media. All rights reserved.
Liz Pulliam Weston, a favorite of ours who puts the common sense to our cents, is here to tell us that the end of these dark ages about our credit scores may be coming to an end.
Free access to your credit scores may be just around the corner. The financial-reform bill recently passed in the Senate passed includes an amendment that would give individuals the right to see their scores if those numbers were used against them in a financial transaction.
In other words, if you were denied a mortgage or insurance, or had to pay more for either one because of your credit, you'd get to see the score that was used to make the decision.
This is a big deal, according to Weston. We've been able to see our credit reports- a history of what we've borrowed and how well we've repaid it- for free since 2003, but the three-digit scores calculated from those reports have continued to carry a price tag.
Consumer advocates, like Weston, have been pushing Congress to give people free access to their scores. But some proposals were mushy on the issue of which scores consumers would get to see.
Knowing the scores
Not all credit scores are created equal, and the credit bureaus are famous for selling consumers "educational" scores that aren't widely used by lenders. And there are many variations of the FICO score, including versions tailored to auto, credit card, installment loan and finance companies that are rarely seen.
"There was a question whether they would wind up with a score that isn't the same one used by the lender or the insurance company," said credit expert John Ulzheimer, who writes for Credit.com and who advised Sen. Mark Udall, D-Colo., in drafting this amendment. Under the amendment language, "you have a right to see the report and the score that was used. It's a transactional score versus an educational score."
Weston acknowledges that this amendment falls short of the full disclosure she has long wanted to see, which would be to ensure all consumers had free access to their FICOs, the credit scores used by most lenders. (Free FICOs, by the way, is a concept supported by Fair Isaac, the company that created the FICO scoring formula, and vigorously opposed by the credit bureaus that want to sell you those other scores.)
What you could expect to see
But this financial-services amendment is a better deal in some ways. If the amendment becomes law- it still has to survive the reconciliation process, in which the Senate's reform bill is merged with the one passed by the House- it will expand dramatically the universe of relevant scores to which you'll have access if your scores cause you a problem.
"In the past, scores like the FICO auto version have been like a unicorn. People talked about it all the time, but nobody had actually ever seen it," Ulzheimer says. "Now you'll get to see the unicorn."
The world of insurance scores is even more diverse. No one formula dominates this industry, as FICO does lending, and many of the largest insurers have their own proprietary scores. Seeing these numbers could start to peel back the mystery of insurance scoring, just as access to FICO scores a decade ago started cracking open the credit-scoring vault. As more people learned their FICOs and how important they were, the pressure mounted for the score's creators to disclose more about how they worked, and today we know far more about the inner machinery.
Another point about the amendment is that it would cut out the credit bureaus, the companies that have made getting your free annual credit reports so confusing in the first place..
The bureaus that run the federally mandated site, AnnualCreditReport.com (the ONLY site giving you completely free credit reports one time per year), hammer consumers with advertisements trying to encourage the purchase of credit scores and credit monitoring, when, in fact, you're just trying to get your free reports.
And some operate look-alike sites that appear to cash in on consumer confusion about where to get free reports.
Rather than giving bureaus another opportunity to profit on your financial information and confuse you in the process, the amendment would put the responsibili Credit report ty on the insurer or lender that was evaluating you. These companies are already required to send you a notice that provides free access to the credit report used in making an "adverse action," or decision, against you. The amendment would add the requirement that you be supplied with the score used.
A little less than advertised
There's one area where the amendment's promoters have tripped a bit, and that's in touting this as helpful to people who are looking for work. The wording says people would have a right to a score if the information in their credit reports was used against them, but employers don't look at scores- they typically look only at credit reports, so no scores would be generated in those cases. Using credit to discriminate in employment is a hot issue- as Weston has written about before- but this amendment wouldn't fix that problem.
Other than that, this could be a monumentally big win for consumers, and that's always a step in the right direction!
John
Copyright 2010 Tesh Media. All rights reserved.
Wednesday, June 09, 2010
USA Today: Only a fraction of those in need file for bankruptcy
By Christine Dugas, USA TODAY
Bankruptcy filings are nearing the record 2 million of 2005, when a new law took effect that was aimed at curbing abuse of the system. Filings could reach 1.7 million this year, says law professor Robert Lawless, but few experts believe that debtors are now gaming the system.
Instead, concern exists about a growing number of Americans who need bankruptcy protection but cannot get any benefit from it or simply cannot afford to file. As their financial problems worsen, that hurts everyone because it can hinder the economic turnaround.
"It's shocking that we are back to the 2005 level," says Katherine Porter, associate professor of law at the University of Iowa. "And the filing rate doesn't even begin to count the depth of the financial pain."
Bankruptcy laws changed in 2005 because filings skyrocketed and credit card companies and banks wanted to weed out deadbeat borrowers. The law made it harder — more expensive and more restrictive — for individuals to file Chapter 7 bankruptcy, which erases most debts.
Instead of seeking protection from bankruptcy, a number of debt-laden Americans have gone into a "shadow economy," or informal bankruptcy, according to some experts.
The signs are there: Student loan defaults and home foreclosures are rising, and bank card loan defaults have increased from 7.7% in March to 9.1% in April, according to S&P/Experian Consumer Credit Default Indices. But during the same two months, bankruptcy filings fell by 4%.
Bankruptcy is supposed to provide a fresh start to people who are in serious financial distress. But only a fraction are filing, Porter says.
'My future is gone'
Carmen Gardiner, 25, a 2007 graduate of Louisiana State University, is weighed down by her private student loans. Her debt is now about $80,000, and her monthly payments are more than $600. Gardiner's undergraduate degree is in psychology. She lives with her husband, who is still in college, and earns $13 an hour at a call center in Atlanta. They have a 6-month-old daughter.
She hasn't defaulted on her student loan. But she doesn't see much hope. Bankruptcy would not discharge her debt.
"I'm completely sour about the whole idea of going to college," she says. "My future is gone before I have a chance to make one. But if I could discharge this using bankruptcy, it would be better than winning the lottery."
There is little information about unregulated private student loan debt. But during an investor meeting, Sallie Mae, the USA's largest private student lender, recently projected that 40% of $6 billion in subprime private student loans will default, according to Student Lending Analytics, an independent research company. That means 360,000 to 540,000 borrowers are likely to default on their loans, SLA said.
The only way that people with private student loans can get help in bankruptcy is if they can prove undue hardship. And to do that they have to go through a separate trial, which is an extra cost, involves witnesses, legal assistance and extra expertise, says Deanne Loonin, staff attorney at the National Consumer Law Center. It is a huge barrier.
But in April, both the Senate and House introduced legislation to allow for private student loans to be dischargeable in bankruptcy. Before the bankruptcy law changed in 2005, only government-issued-or-guaranteed student loans were protected during bankruptcy.
"The high interest rates on private student loans have made them incredibly profitable for loan companies and saddled students with crushing debt," said Sen. Dick Durbin, D-Ill., who first introduced this legislation in June 2007.
Filers pay now or pay later
Only a fraction of those in serious financial distress are filing for bankruptcy, Porter says. In January, she and Ronald Mann, a professor of law at Columbia University, released a paper, "Saving up for Bankruptcy," that probed why that is happening.
For starters, it's simply expensive to file. Attorney and filing fees have risen, and under the new law additional forms, paperwork and attorney liability have added to the cost, Porter says. In the first two years after the law changed, the attorney fees for filing Chapter 7 bankruptcy rose from $712 to $1,078, according to a study by the U.S. Government Accountability Office. And the filing fees increased from $209 to $299.
Many debtors have no choice but to delay filing for bankruptcy. Some wait until they receive a tax refund, and others cash out their retirement savings to pay for a lawyer.
But postponing filing is not good for debtors. It's similar to delaying going to the doctor, because you'll just end up with more problems, says Lawless, professor of law at University of Illinois.
The system is not just more costly, it is more complex. It requires pre-bankruptcy credit counseling. It requires six months of income information and two years of tax returns. And if the debtor holds off filing, a lawyer has to continue to gather new information.
"The paper chase gets greater, and then the fee goes up," says William Brewer, a bankruptcy lawyer in Raleigh, N.C.
Hanging onto their homes
Another reason: Many Americans who are trying to save their homes do not file for bankruptcy. Under the bankruptcy law, filers can protect their summer home and yacht, but they can't protect their primary residence, says John Taylor, president of the National Community Reinvestment Coalition, a non-profit organization.
That wasn't such a big issue when home values were rising. But during the recession, many homeowners are seeing values plummeting and their mortgage payments rising.
Home foreclosure filings have outstripped bankruptcy filings, Porter says. And foreclosure shows no sign of slowing down. In the first quarter of the year, foreclosure filings were 16% higher than the same quarter in 2009, according to RealtyTrac. And March was the highest month since RealtyTrac began issuing reports.
Cordell Brooks, 47, who lives in Temple Hills, Md., may soon lose his home to foreclosure. During the recession he was laid off from his job as a graphics designer. Since then, he has worked as a substitute teacher and now is a contractor with Prince George's County Housing.
"I've gone from earning $40 an hour to $17.50," he says.
Brooks, who has owned his home since 1989, applied for a federal program known as Home Affordable Modification Program (HAMP) but was turned down. He has few options. He doesn't want to file for bankruptcy. But even if he did, it wouldn't help him save his home.
"Bankruptcy is not very useful at solving this particular type of financial distress," Porter says.
Homeowners who applied for loan modifications could have been turned down if they also have filed for bankruptcy. But as of this month, a debtor who requests loan modification cannot be discriminated against because they have filed for bankruptcy, says John Rao, an attorney at the National Consumer Law Center, which specializes in consumer credit and bankruptcy issues. And that will help homeowners who are also overwhelmed by other debt.
Is it time for a change?
When the bankruptcy law changed in 2005, barriers were erected to prevent abuse. But it seems that many honest Americans who are in financial crisis are now running into obstacles. That raises questions about what can be done to prevent debtors from falling through the cracks.
Congress is considering legislation to help college graduates weighed down by private student loan debt. If passed, the legislation could roll back the bankruptcy law so that private student loans can be discharged.
The Treasury Department has agreed to revise the federal mortgage modification program so that people can't be turned down for HAMP just because they have filed for bankruptcy. But some say that this is just a Band-Aid. And now few homeowners are getting permanent mortgage modification.
The 2005 bankruptcy reform did not change mortgage debt. "Debt secured by a principal residence has not been dischargeable since 1978," says Philip Corwin, an outside bankruptcy counsel for the American Bankers Association.
Recent efforts to introduce legislation to allow bankruptcy judges to modify home mortgages have failed. "If Congress had had the wisdom to pass that three years ago we would have forced all the parties to the table to work out reasonable solutions," Taylor says.
The financial industry says that the bankruptcy law is not causing the shadow economy. People can still file for it, and if they can't afford the fees at least the court filing fees can be waived, says Scott Talbott, senior vice president of the Financial Services Roundtable. And people with student loans who have undue hardship are able to get financial relief.
But undue hardship is extremely hard and costly to navigate, says Lauren Asher, associate director of Project on Student Debt. There is no definition in the bankruptcy code of undue hardship, and the court decisions on it have been harsh, Corwin says.
Free legal services have been cut back during the recession and are not available for many debtors. It would help to roll back some of the changes that have increased legal paperwork and risk of personal liability, Lawless says.
The bankruptcy problems are not likely to go away anytime soon. If Gardiner's career is stymied because she can't afford to go on to graduate school and is burdened with student loan debt, doors may be closed to her.
"Not going on with her career and being stuck in a low-wage job hurts everyone and drags down the economy," Porter says. "It is not surprising that the bankruptcy code is not a fit for the problems of today. The 2005 amendment was a move in the wrong direction, and I think it's time to think about redesigning bankruptcy."
Copyright 2010 USA TODAY, a division of Gannett Co. Inc. All rights reserved.
Bankruptcy filings are nearing the record 2 million of 2005, when a new law took effect that was aimed at curbing abuse of the system. Filings could reach 1.7 million this year, says law professor Robert Lawless, but few experts believe that debtors are now gaming the system.
Instead, concern exists about a growing number of Americans who need bankruptcy protection but cannot get any benefit from it or simply cannot afford to file. As their financial problems worsen, that hurts everyone because it can hinder the economic turnaround.
"It's shocking that we are back to the 2005 level," says Katherine Porter, associate professor of law at the University of Iowa. "And the filing rate doesn't even begin to count the depth of the financial pain."
Bankruptcy laws changed in 2005 because filings skyrocketed and credit card companies and banks wanted to weed out deadbeat borrowers. The law made it harder — more expensive and more restrictive — for individuals to file Chapter 7 bankruptcy, which erases most debts.
Instead of seeking protection from bankruptcy, a number of debt-laden Americans have gone into a "shadow economy," or informal bankruptcy, according to some experts.
The signs are there: Student loan defaults and home foreclosures are rising, and bank card loan defaults have increased from 7.7% in March to 9.1% in April, according to S&P/Experian Consumer Credit Default Indices. But during the same two months, bankruptcy filings fell by 4%.
Bankruptcy is supposed to provide a fresh start to people who are in serious financial distress. But only a fraction are filing, Porter says.
'My future is gone'
Carmen Gardiner, 25, a 2007 graduate of Louisiana State University, is weighed down by her private student loans. Her debt is now about $80,000, and her monthly payments are more than $600. Gardiner's undergraduate degree is in psychology. She lives with her husband, who is still in college, and earns $13 an hour at a call center in Atlanta. They have a 6-month-old daughter.
She hasn't defaulted on her student loan. But she doesn't see much hope. Bankruptcy would not discharge her debt.
"I'm completely sour about the whole idea of going to college," she says. "My future is gone before I have a chance to make one. But if I could discharge this using bankruptcy, it would be better than winning the lottery."
There is little information about unregulated private student loan debt. But during an investor meeting, Sallie Mae, the USA's largest private student lender, recently projected that 40% of $6 billion in subprime private student loans will default, according to Student Lending Analytics, an independent research company. That means 360,000 to 540,000 borrowers are likely to default on their loans, SLA said.
The only way that people with private student loans can get help in bankruptcy is if they can prove undue hardship. And to do that they have to go through a separate trial, which is an extra cost, involves witnesses, legal assistance and extra expertise, says Deanne Loonin, staff attorney at the National Consumer Law Center. It is a huge barrier.
But in April, both the Senate and House introduced legislation to allow for private student loans to be dischargeable in bankruptcy. Before the bankruptcy law changed in 2005, only government-issued-or-guaranteed student loans were protected during bankruptcy.
"The high interest rates on private student loans have made them incredibly profitable for loan companies and saddled students with crushing debt," said Sen. Dick Durbin, D-Ill., who first introduced this legislation in June 2007.
Filers pay now or pay later
Only a fraction of those in serious financial distress are filing for bankruptcy, Porter says. In January, she and Ronald Mann, a professor of law at Columbia University, released a paper, "Saving up for Bankruptcy," that probed why that is happening.
For starters, it's simply expensive to file. Attorney and filing fees have risen, and under the new law additional forms, paperwork and attorney liability have added to the cost, Porter says. In the first two years after the law changed, the attorney fees for filing Chapter 7 bankruptcy rose from $712 to $1,078, according to a study by the U.S. Government Accountability Office. And the filing fees increased from $209 to $299.
Many debtors have no choice but to delay filing for bankruptcy. Some wait until they receive a tax refund, and others cash out their retirement savings to pay for a lawyer.
But postponing filing is not good for debtors. It's similar to delaying going to the doctor, because you'll just end up with more problems, says Lawless, professor of law at University of Illinois.
The system is not just more costly, it is more complex. It requires pre-bankruptcy credit counseling. It requires six months of income information and two years of tax returns. And if the debtor holds off filing, a lawyer has to continue to gather new information.
"The paper chase gets greater, and then the fee goes up," says William Brewer, a bankruptcy lawyer in Raleigh, N.C.
Hanging onto their homes
Another reason: Many Americans who are trying to save their homes do not file for bankruptcy. Under the bankruptcy law, filers can protect their summer home and yacht, but they can't protect their primary residence, says John Taylor, president of the National Community Reinvestment Coalition, a non-profit organization.
That wasn't such a big issue when home values were rising. But during the recession, many homeowners are seeing values plummeting and their mortgage payments rising.
Home foreclosure filings have outstripped bankruptcy filings, Porter says. And foreclosure shows no sign of slowing down. In the first quarter of the year, foreclosure filings were 16% higher than the same quarter in 2009, according to RealtyTrac. And March was the highest month since RealtyTrac began issuing reports.
Cordell Brooks, 47, who lives in Temple Hills, Md., may soon lose his home to foreclosure. During the recession he was laid off from his job as a graphics designer. Since then, he has worked as a substitute teacher and now is a contractor with Prince George's County Housing.
"I've gone from earning $40 an hour to $17.50," he says.
Brooks, who has owned his home since 1989, applied for a federal program known as Home Affordable Modification Program (HAMP) but was turned down. He has few options. He doesn't want to file for bankruptcy. But even if he did, it wouldn't help him save his home.
"Bankruptcy is not very useful at solving this particular type of financial distress," Porter says.
Homeowners who applied for loan modifications could have been turned down if they also have filed for bankruptcy. But as of this month, a debtor who requests loan modification cannot be discriminated against because they have filed for bankruptcy, says John Rao, an attorney at the National Consumer Law Center, which specializes in consumer credit and bankruptcy issues. And that will help homeowners who are also overwhelmed by other debt.
Is it time for a change?
When the bankruptcy law changed in 2005, barriers were erected to prevent abuse. But it seems that many honest Americans who are in financial crisis are now running into obstacles. That raises questions about what can be done to prevent debtors from falling through the cracks.
Congress is considering legislation to help college graduates weighed down by private student loan debt. If passed, the legislation could roll back the bankruptcy law so that private student loans can be discharged.
The Treasury Department has agreed to revise the federal mortgage modification program so that people can't be turned down for HAMP just because they have filed for bankruptcy. But some say that this is just a Band-Aid. And now few homeowners are getting permanent mortgage modification.
The 2005 bankruptcy reform did not change mortgage debt. "Debt secured by a principal residence has not been dischargeable since 1978," says Philip Corwin, an outside bankruptcy counsel for the American Bankers Association.
Recent efforts to introduce legislation to allow bankruptcy judges to modify home mortgages have failed. "If Congress had had the wisdom to pass that three years ago we would have forced all the parties to the table to work out reasonable solutions," Taylor says.
The financial industry says that the bankruptcy law is not causing the shadow economy. People can still file for it, and if they can't afford the fees at least the court filing fees can be waived, says Scott Talbott, senior vice president of the Financial Services Roundtable. And people with student loans who have undue hardship are able to get financial relief.
But undue hardship is extremely hard and costly to navigate, says Lauren Asher, associate director of Project on Student Debt. There is no definition in the bankruptcy code of undue hardship, and the court decisions on it have been harsh, Corwin says.
Free legal services have been cut back during the recession and are not available for many debtors. It would help to roll back some of the changes that have increased legal paperwork and risk of personal liability, Lawless says.
The bankruptcy problems are not likely to go away anytime soon. If Gardiner's career is stymied because she can't afford to go on to graduate school and is burdened with student loan debt, doors may be closed to her.
"Not going on with her career and being stuck in a low-wage job hurts everyone and drags down the economy," Porter says. "It is not surprising that the bankruptcy code is not a fit for the problems of today. The 2005 amendment was a move in the wrong direction, and I think it's time to think about redesigning bankruptcy."
Copyright 2010 USA TODAY, a division of Gannett Co. Inc. All rights reserved.
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