Financial Planning

You’ve seen the advertisements online, “Wipe out your credit card debt! Terminate Credit Card Debt! Eliminate Credit Card Debt Legally!” Can this be true? Is there a way to erase all of your credit card debt, legally, without paying? I haven’t tried this method personally, but with a little research online, this is what I found:

They Say the Banks Are Responsible

Debt elimination companies allege that when your credit is established and your credit limit is set, the banks are the ones that sign their name and take responsibility for your credit card debt. You can think of this like a co-signer; if you don’t pay, they are responsible. They point out that this is why your credit card company can call you, report the debt to creditors, but it is unlikely that they will sue you. If this is true then why doesn’t everyone simply ignore their credit card debt and why would these companies take the chance that you will pay them back?

They Say You Can Erase All Debt Because of Hidden Laws

It is also alleged that there are policies, procedures and statutes that banks and other financial institutions are required to follow, legally, that protect you from having to pay. The debt relief companies point out that they know the laws, they have been doing this for years and they understand the loopholes. With their help, you will be able to obtain a clean credit report, and oftentimes even be able to erase the money you owe for this service. Sounds wonderful, right?

They Want You to Buy Their ‘Fix-All Program’

What I didn’t find in my research, were any companies that were assured enough to offer guarantees. Most want to sell you their sure-fire ‘erase debt legally program’, which you must pay for upfront. These super-top-secret programs will help you to become debt free without paying a dime…except the dimes you pay for the program and I’m betting that there is more money to be paid after you acquire the program.

In the end, I remember two sayings: If it sounds too good to be true, it probably is and, you can’t get something for nothing!

Do you have several credit cards that have reached their limits and you find that paying the minimum monthly requirement is getting difficult? If you add the expenses of car payments, insurance, and mortgages on top of your mounting debt this can lead to a feeling of being financially overwhelmed. The way a debt reduction service operates is when you owe a particular balance to a creditor and negotiate to pay a lower balance. This differs from debt consolidation in that when you consolidate you pay a lump sum to an agency that then disperses the monies to the creditors that you owe. Creditors will agree to debt reduction if they believe that it is in their best interest.

Typically, those who request debt reduction services are individuals who are considering the option of bankruptcy as a form of clearing out their debt. Certain situations affect the pay off amount that creditors will offer. They will look at your credit report to see how you are paying your other debts. If it appears, you are paying everyone else in a timely fashion and neglecting them, they will most likely offer a high settlement based on the fact you appear to have the finances to be faithful to your other obligations. On the other hand, if they notice that your credit report shows you are not paying anyone they may offer a lower settlement. If their offer is in your opinion to high, then you can gather your financial information, including all incomes received and outgoing expenses to negotiate for a lower settlement offer.

When you have received a settlement offer either through a company you have hired or through negotiating yourself the creditor expects you to pay off the settlement with a one-time lump sum payment. There are exceptions to this rule such as if your debt is significantly high the creditor may consider payment arrangements over a short period. Usually they will offer up to six months. Another option is in using a debt reduction service that can negotiate for the settlement payments to stretch over a period up to four years.

The idea of using debt reduction services as a form of reducing your debt in and of itself sounds like a great idea. There are some points to consider if you are an individual who has good credit and has found himself or herself in a difficult spot financially, consider carefully before engaging in a debt reduction service. Once you do use this method, it will significantly lower your credit score, making obtaining credit more difficult. If you, on the other hand, are someone who has had a history of poor credit actually using a debt reduction service can change your bad credit rating from poor to good thus enhancing your credit status.

Different companies have different criteria for evaluating good credit. An employer, for example, might consider having zero credit cards as good credit. A credit card company might consider having credit cards that are spent to the limit as good credit, as long as the payment history is perfect. A mortgage company, on the other hand, does not consider maxed credit cards as favorable.

How does mortgage credit differ from other types of credit?

You might hear about the conventional wisdom of good credit. For example, it’s good credit when you have paid off your credit cards in full. Don’t carry a balance on your credit cards. Close credit card accounts when you don’t need them anymore.

While this is good, solid advice for debt management and control, if you’re trying to get a mortgage, it can work against you.

When mortgage companies evaluate applications, they like to see consistency. If you have a credit card, mortgage lenders want to see at least 24-36 months of perfect payment history on it; that is, 24-36 months with no breaks in between. If you’re fortunate enough to be able to pay your credit card off every month, you might want to rethink this strategy if a mortgage is in your future.

If you allow a paid-off credit card to remain that way for at least 2 straight months, your credit report will show a break in your payment history. Over the past 12 months, it might look something like this on your credit report:

CCCC CC CCCC

Mortgage lenders want to see this on your report:

CCCCCCCCCCCC

If you already have perfect credit with high scores, this isn’t much of an issue. However, if your scores are lower, or if you’re trying to rebuild credit, it is very highly recommended that you maintain a consistent payment history with no breaks. How can you do this without getting yourself into a mess of debt? You can put an inexpensive magazine subscription on your credit card, for example. That way, you never need to carry the card around, and it’s automatically charged for your subscription amount. Just make sure that you pay it off every month on time.

Conventional wisdom tells you to keep a zero, or almost zero, balance on your card. When it comes to mortgage lending, however, it is a dangerous trap. If you have a very low balance on a card, mortgage lenders will look at the “potential” of you maxing out that card. If you were to do that, your debt ratio will increase, and you could default on your loan. The higher your credit limit, the more this becomes an issue. A $300 credit card with a $20 balance won’t matter as much as a $3000 credit card with a $200 balance. In the latter scenario, you have the potential to add $2800 to your current debt load.

Generally, lenders like to see around 25% to 50% of your credit line used up. That way, it lessens the hit on your debt ratio if you were to max the card out. While this criterion by itself might not be enough to approve or deny you, it is definitely a factor worth considering.

If you have no balances on your cards, why not close the account? Then the low balance issue is moot, right? Unfortunately, closing accounts will lower your credit score. As well, lenders like to see at least 3-6 revolving accounts on your credit, and at least 1-2 installment loans. If you have too many revolving accounts with no balances, then you might want to close some. But if you’re in that 3-6 range, keep them open.

Obtain a copy of your credit report and see how your credit history reads. Make sure there aren’t any breaks in your history, especially if you’re a borderline applicant. Even if you do have a break, a high credit score will offset any penalties your potential lender might invoke. Keep the score as high as you can, and keep your credit history consistent.

Debt reduction companies are everywhere. They advertise that you can “reduce your debt by 70%” or “become debt free quickly and easily.”

You have to take these advertisements with a grain of salt. You simply don’t know exactly what they mean. One thing that they could be talking about is bankruptcy. Many companies and debt reduction agencies are simply fronts for bankruptcy attorneys. A Chapter 13 bankruptcy could reduce your debt. But it completely ruins your credit report. It will usually cost you more in the long run, especially if you want to buy a home or take out a loan in the next decade.

It could be that the advertisement is talking about a debt consolidation loan, a home equity loan or a quick refinance of your home. If you don’t own your home, they aren’t going to help you. They are really just looking to make money off of your loan fees.

Some companies have you make a single payment to them and then they pay your bills for you. It is nice to pay one bill instead of ten, but there are large monthly fees for this service. Do you really want to pay someone to pay your bills for you? Especially when you are having money issues?

You should be cautious of companies that require a large up-front fee and monthly fees to manage your bills. You should also watch out for companies that say they can clean up your credit report. These companies don’t do anything that you can’t do on your own. They simply take your money.

And remember that you can’t believe everything you read or hear, especially in advertisements.

Everyone’s debt situation is unique and determining what will work best for you begins with categorizing your debt. Whether your debt is secured or unsecured significantly effects the measures you can take to eliminate debt.

Secured debt is a loan which is “secured” by property. Simply put, if the bank can come and take something from you if you don’t pay (ie; home, car) then the debt is secured.

Unsecured debt is the most common type of debt and is typically in the form of credit card debt.

Eliminating Unsecured Debt

The three most common ways to eliminate unsecured debt are

1. paying as agreed

2. bankruptcy

3. reaching a settlement with the creditor for less than the balance due – also known as debt settlement or debt negotiation

Bankruptcy is rarely a viable option. Due to the changes to the Bankruptcy Law in 2004 by the Bush administration, estimates are that less than 10% of people who file for bankruptcy are successfully discharging any debt. Most have to pay it back now under Chapter 13.

Credit Counseling and Debt Consolidation services typically focus on eliminating your debt by settling with your creditor for less than the balance due. These services are typically owned by large banks and credit companies and typically charge a fee. The good news is, this is something you can do on your own.

Settle For Less than the Balance Due

The key to a successful settlement is leverage. If a bank thinks they can get more out of you, they will not settle. This means that you may have to go months without making any payments. This will reflect poorly on your credit report and affect your credit score, but it is a necessary to obtain a good settlement.

During the time you are not making payments to the credit card company they will constantly attempt to contact you to discuss it. This is best dealt with from the very beginning by sending them a letter requesting that they only contact you in writing. Also, it is very important that you familiarize yourself with your rights under the Fair Debt Collections Practices Act and the Fair Credit Reporting Act. Collections representatives often behave in unscrupulous ways and knowing your rights is your key to fighting back.

Once you have sufficient leverage against the company it is time to attempt a settlement. A realistic goal would be to settle the debt for between 35%-50% of the balance. Contact the bank or credit card company directly and they will likely transfer you to their collections department. Once in touch with the collections representative simply let them know you wish to resolve the debt. Typically, they will make you an offer to settle for 65%-80% of the balance before you ever make an offer to pay. Let them know what you do have; an initial offer of 15%-25% of the balance is reasonable. They may tell you no or tell you that they have to speak with their manager but continue the negotiation as necessary to settle within the range that you desire.

Some credit companies are more apt to settle than others. For instance, American Express can be a very difficult company to settle with for less than 60%. Search the internet for information on your particular bank or credit card company to see how others have fared.