Debt Settlement ... why?

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The internet is full of ads for debt settlement companies as well as articles on why people should not use these services. Debt Settlement (or sometimes referred to as Debt Consolidation) is when a company collects money from a debtor and creates a stockpile of cash to negotiate settlements on debt. For a more detailed discussion on the debt settlement see my Blog - Debt What? (see link below)

It never sounded like a good practice to me. Recently, I had two clients who came in and started down this path. Their experiences reinforced my belief.

After reviewing the cases I realized the clients would probably do better filing for bankruptcy protection under Chapter 13.

One client completed the paperwork and was going to pay about $750 per month to settle only his largest debts. He decided it was not a practical choice and came to me.

The second client started her payment program before her family talked her out of it. I got my first look at a payment schedule from one of these companies. She had approximately $32,000 in debt to settle. She was scheduled to make two payments of $664 and 46 payments of $465. After reviewing her payment schedule, I have to ask ... Why? why debt settlement ...

Under her debt settlement plan, she was going to pay fees of $9,000 to the settlement company and an "ESTIMATED" $13,000 to settle the full debt. The payment plan extended over 4 years. It should be noted at the bottom of the payment schedule in fine print, it stated, "Settlement Reserves above is only an estimate of the amount needed for settlement." To me, this means  the settlement is not guaranteed after 4 years and paying $13,000.  

Under a Chapter 13 payment plan, the same client could pay approximately $5,000 in fees (attorneys' fees and court costs) and $13,000 towards the debt and discharge the remaining debt. The payment plan in Chapter 13 could be completed in 3 years.

Why debt settlement when you can set up similar payments, pay about the same amount on your debt, save about $4,000, and do it all one year faster.

The irony of both these cases is these plans would have failed. When I sat down with these clients and asked questions probing and poured through their records, we found they did not have the disposable income they believed they had.

It is common for people who desperately want to pay their bills to over estimate the money they have to do it. We determined both clients were eligible to file for bankruptcy protection under Chapter 7, which is much less expensive and much shorter in duration. 

For those who want to review the details:

Though the plan listed my second client's gross income as about $1,700 per month when she was really bringing in around $1,100 and that was a disability payment. Giving the debt settlement company the benefit of the doubt, they probably relied on the debtors representation without much probing. The fee schedule had her paying about $664 per month to the plan for the first two months and $465 for the remaining 46 months. Depending which gross income figure you use, she committed to paying 27% - 42% of her gross income into this plan.

The more shocking part is the distribution of the payments. First, there is a $399 enrollment fee. After the enrolment fee is paid, there are a series of monthly fees: Service Fee - $340; Maintenance Fee - $59; Trust Fee - $10, which equals $409 per month to fees. This left her under $56 per month in her account to work on the settlement of her debt.

After six months, the service fee dropped to $213 per month for 18 more months. At the end of two years, my client would have paid $5,900 to the settlement company and saved or spent $3,600 towards settling her $32,000 debt. If she were able to make payments beyond two years, the service fees drop to $69 per month for the last two years. After four years, the plan "ESTIMATES" it will settle the debt for about $13,000 and charged a total of $9,000 in fees to the client saving the client a total of $10,000 on the debt.

Consider a similarly situated person who wants to pay the creditors something back and has $465 per month in disposable income to contribute to a payment plan. He or she may have an option to file for bankruptcy protection using Chapter 13 protections and only need to commit to a 36 month payment plan. The debtor would pay $310 filing fee, $50 for credit counseling, and $1,500 - $3,000 attorney's fee.

The cost to file for bankruptcy would be $3,360. Then the person would make 36 payments of $465, which equals $14,880. The bankruptcy trustee can charge up to 10% of the debtor's payments or $1,488, which would be deducted from the money being paid through the plan.

As a result, the debtor would pay approximately $4,848 in "service fees," $13,000 on the debt: saving $14,000 and one year's time in payments.

RECAP: A debtor in the financial situation described above could save $4,000 (or more depending on attorneys' fee and trustee fees actually charged) and 1 year in time using Chapter 13 Bankruptcy over a debt settlement plan.

In some instances, a person in a similar position will qualify for bankruptcy protection using Chapter 7. He or she would pay $335 filing fee, $50 for credit counseling, $1,000 - $2,000 in attorney's fees, and the case would be over in about six months.

If you want assistance, legal representation, or just want to know more about Mark M. Medvesky or Wells, Hoffman, Holloway & Medvesky LLP, check out our website at www.whhmlaw.com.

Related Blog Entry - Debt What?

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