Debt Consolidation

Q: I have a friend who sought help from a debt consolidation company. She had to pay a lump sum of several hundred dollars just to open an account, and her credit report was not helped. Isn't there a better way to get out of debt?

A: It looks like your friend may have become involved with a "debt settlement" company, not a "debt consolidation" company. They are not the same thing, and consumers seeking solutions to their debt burdens should understand the difference.

During the past few years of low mortgage rates, the term "debt consolidation" has been used heavily by companies marketing home equity loans to help consumers consolidate their debt. The term has been used in the credit counseling industry and by a wider range of financial services companies.

Debt consolidation simply means making one monthly payment instead of paying several different creditors each month. To accomplish this, the consumer would transfer the debt from the multiple accounts to a single account, such as a home equity loan or line of credit.

Similar to debt consolidation, a debt management program offers the consumer the ability to make one payment to the counseling company, which then makes the payments to the various creditors. Strictly speaking, the debt is not really consolidated. But for the consumer, managing debt becomes easier.

More importantly, these credit counseling agencies may offer other benefits to the debtor, such as negotiating lower monthly payments and interest rates to enhance the ability to catch up on overdue payments. Before enrolling in a debt management program, most reputable agencies will require the consumer to participate in a budget and counseling session to ensure that such a program is the best solution.

When a consumer begins drowning in debt and the collection calls start coming, solicitations from debt settlement companies usually are not far behind. While it may seem prudent to hire a professional firm to negotiate a settlement of the outstanding debt for less than the actual amount owed, the consumer should tread carefully. As your friend discovered, the debt settlement company sometimes charges an initial "administration fee" totaling hundreds of dollars simply to set up an account, plus monthly service fees.

As an example, the Federal Trade Commission (FTC) took action in 2004 against a company that advertised its services by saying it could negotiate with creditors to reduce a consumer's debt by 50 percent. However, according to the FTC, the company charged fees totaling hundreds or even thousands of dollars.

Among many transgressions, the company allegedly told consumers to stop direct payments to their creditors, claiming that the consumers' failure to pay would demonstrate a "hardship" condition and thus enable the company to negotiate on their behalf. Indeed, the consumers were instructed not even to talk to any creditors for any reason.

The company also told consumers, according to the FTC, that negative information may appear on their credit reports but only temporarily. In fact, the Fair Credit Reporting Act states that negative information must remain on a credit report for a minimum of seven years.

To be fair, this example is a case of criminal fraud, and many debt settlement companies lawfully attempt to settle debts on behalf of consumers. However, these companies sometimes fail to ask creditors to stop the accrual of interest, late fees and over-the-limit fees; the bills continue to grow while negotiations continue. So if the consumer is hit with a lawsuit and an unfavorable judgment, he or she may owe more money than at the start of the debt settlement process!

If a consumer stops paying his or her bills for any reason - except in the event of a personal bankruptcy proceeding with the representation of a competent attorney - creditors retain the right to take legal action and possibly garnish wages.

The least expensive way to settle personal debt - and the least harmful to your credit report - is to speak directly to your creditors and attempt to settle the accounts or agree to repay the debt on terms you can afford. And waiting only makes the problem worse. Talk to your creditors as soon as you start to fall behind in your payments.

 

Mike Schiano is Vice President of Outreach for InCharge® Education Foundation, a non-profit credit organization whose mission is to provide consumers with information and resources to make smarter family financial decisions. Listen for Mike's daily radio feature, "Military Money Minutes" on Armed Forces Radio Network. E-mail: mike@askthedebtbuster.com.