In a press release by Morgan Drexen (Morgan Drexen Warns Consumers: If You Choose Bankruptcy You Could Face a Devastating 240 Point Decline in Your FICO Score) the debt settlement company draws the conclusion and states “Perhaps the difference between debt settlement and bankruptcy, when it comes to FICO scoring, is simply this: through debt settlement, the consumer is making an honest attempt to pay something to a good faith creditor, rather than just walking away from his or her financial responsibilities through bankruptcy.” and “Now that FICO has revealed the inner workings of its scoring method, it’s clear that debt settlement is a better option for many consumers,” says Ledda. “And in spite of the nonsense that’s being spread by credit card collectors, not only can debt settlement substantially reduce the principal, reduce fees and penalties, and lower outrageous interest rates, it does so with less damage to your credit score than bankruptcy.”
That is the craziest interpretation of the FICO report I’ve seen. Obviously one that is self-serving to the debt settlement industry.
I especially enjoy the statement “Perhaps the difference between debt settlement and bankruptcy, when it comes to FICO scoring, is simply this: through debt settlement, the consumer is making an honest attempt to pay something to a good faith creditor, rather than just walking away from his or her financial responsibilities through bankruptcy.” Now isn’t the basic tenant of debt settlement that you are paying your debt back for less than you owe? And how is that not walking away from your debt?
The other astounding statement is that bankruptcy results in a bigger negative impact than debt settlement. But nearly all people who engage in debt settlement are told to let their accounts go past due, face a potential lawsuit, have part of their debt written off and then, and with fingers crossed, reach a potential settlement deal.
So let’s add up what FICO did revel, Bankruptcy with a credit score above 780 could result in a 240 point drop, but most people going bankrupt don’t have a score above 780. So bankruptcy with a score of 680 results in a 150 point drop. Plus we have to add in the 80 point delinquent penalty and the 65 point debt settlement penalty. Chances are the card was nearly maxed out as well for another 30 points but I won’t count that. Nor will I add in the lawsuit and public records listing on the credit report in debt settlement and what that could ding you with as well. So in reality the debt settlement point drop could be 145 as compared to 150 with bankruptcy.
In addition debt settlement can take years but bankruptcy provides immediate relief, stops collections and blocks all lawsuits. Certainly that has to be worth a tiny 5 point difference.
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21 thoughts on “Debt Settlement Companies Draw Wrong Conclusion About Recent FICO Score Facts”
As for the bankruptcy. I totally agree. It is the ideal solution for many businesses and individuals. Talk to a lawyer if you have secured debts, including a house that is at risk. Jeff, maybe you could elaborate on Chapter 7 and 13. I understand that most consumers that the products are not eligible for Chapter 7, where all debts are forgiven. In Chapter 13 to repay almost all its debts of more than five years? Therefore, the reconstruction of their financial credibility does not start until you are bankrupt, right? I ask here, does not specify.
I think this is a fantastic topic and truly deserves much more focus by media and consumer advocates.
Increased economic and financial turmoil
Employment and income loss across every demographic
Information overload (with & without bias) on the topic
More consumers are looking for answers and information that will assist them in evaluating their options for dealing with personal financial problems while keeping an eye on their future needs and goals.
Credit reports and scores are affected no matter what option a consumer embarks upon. Consumers need to focus on the math first. There is no emotion or hangups when dealing with the numbers. If the math does not support paying the debt, then what? What do each individuals numbers support?
I wrote a brief article on this last week. It is quick and to the point:
Anyone “selling” settlement as an answer based on the effects to future credit angle, who can only fit a consumer into a 30 plus month program and where the consumer can qualify for chapter 7 bankruptcy, is not helping the consumer, but likely helping themselves to a fee.
Many people will want to avoid bankruptcy that shouldn’t.
Many will file who could have avoided it.
Philosophic debate on a no debt society is a worthy effort.
Problem is, our entire economy is debt based. The path to a low-to-no debt based economy would be uncomfortable to say the least. Healthier overall once we get there? Absolutely, but man will it hurt along the way!
Narrow this down to the individual consumer who is stuck in a debt trap and wants to get out. Healthier when they get out, but there will be some lumps to take along the way.
One lump is the credit score/report.
Liz’s comment on the lack of predictability is spot on from my experience. I will however, go out on a limb with a prediction of my own:
In an effort to assist in economic recovery, there will be legislative changes in a few years that will impact conventional wisdom on this topic.
.-= Debtbytes´s last blog ..How’s that working for ya Mr. Banker? =-.
Kristy, sorry I did not explain myself very well there.
Credit Scores and the fear of having a low one often compels consumers to make poor financial decisions.
I need a credit card to improve my credit score.
I will finance that car because it will help my credit.
I will open that dept. store card because it will help my credit.
If I do not charge on my card, then I will not improve my credit.
And so on.
Combine that with the “keeping up with the Jones syndrome” and you have a recipe for a nation in debt. And that is where we are at.
So the point in regards to credit is that, it should not drive your financial decisions. If you remove the thought that you MUST use credit and finance your lifestyle, then you will see that credit and credit scores have less and less of a necessity to you. This is strictly from a consumer credit position. Do you want to intentionally have bad credit, of course not. Do you need to become debt free before you have the financial ability to reject credit and borrowing? Yes. But I believe each person should re-evaluate what credit is to them, if they need it. The sooner you can eliminate your debt, stop paying interest to others, and start investing in yourself, the sooner you will become financially independent.
Businesses leverage credit all the time, and for the most part perform their due diligence to ensure that the debt is leveraged as an investment that will pay dividends. A consumer purchasing an MP3 player, TV or Big Mac has little return on investment.
In regards to bankruptcy. I absolutely agree. It is the right solution for many businesses and individuals. Speak to an attorney if you have secured debts, especially a home that is at risk. Jeff perhaps you could elaborate on Chapter 7 and 13. As I understand it most consumers with any income do not qualify for Chapter 7 where all of your debts are forgiven. In a Chapter 13 you pay back virtually all your debts over 5 years? So the rebuild of your financial credibility does not start until you are out of bankruptcy, right? I’m asking here, not stating.
In addition, I have read in the Bankruptcy Act of 2005, that if the court, IRS, or other government dept finds that you were not truthful on your bankruptcy petition, you hid an asset like your prized set of Golf clubs, they could cancel your bankruptcy, regardless of how long you have been under the bankruptcy courts program! You will be responsible for the entire debt load.
Settlement fees are definitely a point of confusion.
You should use an example debt if you are going to give a price. I am familiar with hundreds of settlement models. My research shows a 10-12% fee, some at 8% or less. This is on the total debt taken into the program. This is generally paid over the first year of service. So on a 30k debt, you have a $3k fee, paid as $250/month for a year. Other companies charge a nominal flat fee of $500 and then a 20-30% success fee on the amount they reduced your debts by. In that case if your debt was reduced by $15,000 they would charge you $3,000-$4,500 + the $500 up front fee. I won’t compare this to bankruptcy costs as the services performed are totally different. A lawyer could help save my home and man that would be worth it.
7 Facts That The Average Debt Settlement Company Won’t Tell You
In a recent article, I debunked a blog entry by J. Carlton Ford, owner of a website called Debt Warriors. Mr. Ford is a sales associate for Pre-Paid Legal, Inc. and sells “coaching videos” that purport to teach debtors how to reduce their debts. The cottage industry of “quick fixes” to debt problems is a sign of growing desperation by debtors who are confused about their options. Whether purchasing a video from someone like Mr. Ford or considering the use of a “debt settlement company”, consumers should be wary of quick fixes and empty promises of easy solutions.
Debt settlement companies offer to negotiate directly with your creditors, often for fees from ranging from 9%-16% of the consumer’s total unsecured debt. But debt settlement plans can harm debtors in ways they never imagined.
1. Debt Cancellation/Forgiveness is Presumed to be Taxable Income. Generally, if you owe a debt to someone else and they cancel or forgive that debt, you are treated for income tax purposes as having income and may have to pay tax on this income. If you owe a credit card company $10,000 and settle the account for $5000, the credit card company will send you and the IRS a 1009 form showing $5000 of income for the forgiven debt. You may be trading a debt that is completely dischargeable in bankruptcy for a nondischargeable tax debt. Debt forgiveness achieved in bankruptcy is not taxable.
2. Debt Settlement Plans Are Not Binding On All Creditors. Creditors do not have to deal with the debt settlement companies. Some creditors like American Express usually refuse to do so. If a creditor does not agree to the proposal, the creditor can sue you to obtain a judgment and garnish your wages and take your assets. A chapter 13 repayment plan is binding on all of your creditors and the automatic stay created by the filing of a bankruptcy prohibits any of your creditors from suing you.
3. A Debt Settlement Company Cannot Represent You In Court. Unless the debt settlement company is also a law firm, it cannot legally represent you in court. If you do not hire any attorney or do not have sufficient legal skills to represent yourself, then you risk have a judgment entered against you.
4. Debt Settlement Plans Are Often More Harmful to Your Credit Than Bankruptcy. Unless your debt settlement company skillfully crafts a settlement agreement the correct way, your creditors can still continue to report you as delinquent. While filing for bankruptcy will impact your credit, the automatic stay prevents creditors from reporting further negative information. In the case of a Chapter 7 discharge, creditors must start reporting zero balances within 30 days of your discharge and you can quickly distance yourself from any bad payment history. You can actually have bad credit longer under a debt settlement program than when filing for bankruptcy.
5. Debt Settlement Plans Are Often More Expensive Than Attorney Fees For Bankruptcy. In the Southern District of California where I practice, most consumer Chapter 13 cases cost approximately $3300 in legal fees plus expenses such as the $274 filing fee. Chapter 7 fees are often less than half of what an attorney might charge for a Chapter 13 bankruptcy. A person with $30,000 in debt will often pay a debt settlement company more than they would pay an attorney to file for bankruptcy.
6. Bankruptcy Can Accomplish More Than Debt Settlement Plans. Debt settlement plans typically only deal with unsecured debts such as credit cards and medical bills. Debt settlement plans usually do not deal with taxes or secured debts such as a home or car loan. Using bankruptcy, debtors can discharge certain income taxes, modify certain types of loans and many debtors are even using Chapter 13 bankruptcy to remove second mortgages from their homes. Debt settlement plans cannot accomplish any of those things.
7. Most Debt Settlement Companies Use the Carrot On a Stick Approach. Debtors rarely have the money to offer lump sum settlements to creditors. Debt settlement companies will often take installment payments and collect their fees first. Once they have a sufficient pot of money, they will offer a token settlement to one or two creditors. While this is happening, creditors may sue the debtor and the debtor’s credit rating will continue to drop.
While debt settlement plans may have their place, I have yet to see a satisfied customer come through my doors. If you are in financial difficulty, a consultation with a qualified bankruptcy attorney is always a good choice and often free.
All the above comments are worthy of debate. No one “fix” is perfect for everyone. Debt Settlement may be a great option for certain consumers, and for others it is not. What consumers need to do is speak to both options before making a decision.
With that said, I agree with Steve in the fact that the article is misleading. FICO assigns point drops based on events. No two consumers/debtors are going to end up with the same result because the course of events that lead them to either “Debt Settlement” or “Bankruptcy” will be different, and all those different events will affect their scores differently.
A few points to keep in mind when weighing your options are: 1) The Ability to Begin Rebuilding Your Credit Score; 2) The Cost of the Debt Relief you Choose; 3) Secured Creditors; and 4) Finality.
1) Ability to Quickly Rebuild Your Credit Score: Debt Settlement is a longer process than Bankruptcy when it comes to impacting your credit score. The longer you are in Debt Settlement, the longer it will be for you to begin “Rebuilding” your credit ratings. When you file bankruptcy, everyting stops. If you were only 30 days in default, you will not be 60 days in default the next month. Yes the fact that the debt was discharged will be reported for the next 10 years, but the impact is that one event and you can almost immediately begin to rebuild your credit score. Likewise, there are many financial institutions that provide financing to bankrupt individuals, helping them move on and begin rebuilding their credit.
2) With respect to Cost, Bankruptcy, in my opinion, is the most efficient and economical. If you are a Chapter 7 Debor your costs may range from $1000.00 to $4,000.00 (Our fees are typically much lower than $4,000.00). For a Chapter 13 Debtor, the attorney fees and filing fees may range from $2500.00 to $5,000.00. A Chapter 13 also gives the debtor the opportunity to pay something to their unsecured creditors.
Debt Settlement, on the other hand, could cost you $400.00 or more per month for the next 36 months ($14,400.00) with little guarantee that all your unsecured debts will be satisfied.
3) From what I know about Debt Settlement, secured debts are not included in the program. Therefore you must continue to deal with your secured creditors on your own. With bankruptcy, All Assets and All Liabilities are disclosed and accounted for.
4) Finality. I think most commentators will agree that Debt Settlement does not guarantee anything other than to collect your money and try to settle with your creditors. Your only involvement is paying the monthly amount and fighting your own lawsuits.
Bankruptcy has the Federal Government behind it. Creditors will participate and Debts will be settled. The most likely reason for bankruptcy to not be successful is if the debtor fails to perform.
For more comparative information on Debt Settlement and Bankruptcy, please see http://preview.tinyurl.com/r4epnj
Jacob – Your comment: “The belief you must have good credit because it gives you the ability to finance at a lower rate sends consumers in the wrong direction.” makes me scratch my head and go “huh?”.
Having poor credit absolutely increases the cost of borrowing money. I’ve had poor credit myself and I can tell you first hand that it’s true. How can you make such a statement?
.-= Kristy Welsh´s last blog ..Credit Bureaus Don’t Really Investigate Disputes =-.
Just a point of clarification: You can’t predict the effect of a number of different actions on your credit scores just by adding up the point damage of those different actions. The effect on your scores could be more or less than what’s indicated in the chart. FICO revealed some info about how various actions, taken separately, would affect two specific hypothetical consumers, and I’m appalled that a debt settlement company would use that to infer settlement was better for all consumers.
I asked our friend Craig at FICO for feedback on that and I have not heard back. Maybe you could ask him as well.
Credit is the issue.
The belief you must have good credit because it gives you the ability to finance at a lower rate sends consumers in the wrong direction. I say, you should not be financing in the first place, but saving, investing and purchasing on a cash basis. Virtually every purchase in a consumer’s life can be done this way. Yes, even homes. Think about it, if people did not over finance their way into homes they could not afford, how high would prices really go?
I don’t care what debt relief strategy a person takes, so long as they become debt free and stop falling for the old line of you have to have a credit card and keep a high FICO score and other tricks to keep you borrowing. Consumer Credit and related scoring is a tool to ensure consumers keep borrowing and paying interest on everything.
Use the appropriate debt relief solution for the right financial situation. Credit Counseling bashing Bankruptcy makes no sense. Neither does Bankruptcy Vs Settlement. They all are legitimate solutions which are used to address different circumstances thus have very different requirments and pros and cons.
We can definately demonstrate there are bad players in credit counseling, settlement, bankruptcy and many financial services. This does not render each of the industries as scams. In need of oversight perhaps.
I would like to know the mortgage company that is willing to offer a nice low interest rate home loan to a person who filed bankruptcy within two years.
The landlord that would rent to a person who recently filed bankruptcy, without any additional deposit and at a normal market rental price.
The used car dealer extend that low rate loan and fair price to the bankruptcy consumer.
The employer hiring the bankrupt person to work for his all cash business, or a business that gives access to assets.
To suggest there is little to no additional cost to bankruptcy over the long haul I don’t believe is being 100%truthful. You, being experienced and dilligent, may have navigated wisely through these obstacles. However, few consumers can do the same. There are similar consequences to credit counseling, Debt Settlement and any debt relief service.
So in summary, instead of comparing these services against each other, we should be explaining which one is more appropriate for specific financial situations. Then discussing pros and cons of making that choice.
Mortgage – I said three years.
Rent – Private landlords do it all the time.
Car – New car rates are available after two years.
Employer – No study showing relationship between work performance and credit report.
Have you ever written a post that specifically compares Debt Settlement vs. Bankruptcy? after reading this post and the comments, I do agree with Jacob that the title is sort of misleading…
Yes, read “The Truth About The Failure Rates and Completion Rates of Credit Counseling, Debt Settlement, and Bankruptcy.”
Steve, I know we could point and counter point all day long here.
I, as you have plenty of ammunition to support a case of extortion on people with poor credit and bankruptcy on their record by businesses and services. I do not doubt your personal experience with bankruptcy. I was trying to make two core points.
Bankruptcy and Negotiation are two very different solutions. There is a great deal of misleading information on both, the sensational general title was what caught my eye. I am not a settlement advocate by any means.
The larger point is the psychology that goes into poor financial management. You point to credit scores, borrowing and financing consumer purchases. I say this is what leads to debt, bankruptcy and debt settlement for millions of Americans. I suggest that consumers should stop allowing a credit score to dictate their financial plan and try and view their finances in a new way.. without leveraging debt.
If you study the history of economics in societies and how national leaders used monetary tools you will find that Governments, Businesses and Politicians need consumerism and debt to achieve control, power and wealth. This is 101 to many I know. In a free country this is not all so bad, however when it gets out of balance all hell can break loose, as it recently has.
I just have a negative reaction to advice that says, hey get out of debt so you can rebuild a credit score so you can borrow more money and get back into debt!!!
“I just have a negative reaction to advice that says, hey get out of debt so you can rebuild a credit score so you can borrow more money and get back into debt!!!”
I think you are extrapolating your own negative emotions and assumptions here. I never encourage someone to go back into debt they can’t pay and people who live through these situations don’t want to repeat them.
But like it or not the reality is we also live in a framework that requires good credit. So many other things are based on the quality of our credit score and the only way to improve that score is to build it back up.
Credit never was the issue here. It is the underlying factors that lead the person into the spot they are in today. The debt is the symptom.
And as far as the history of debt in America, I know it well. You might be interested in my section on the History of Credit and Debt.
The article above states one Debt Settlement company made this claim, yet the title suggests a group or all “Debt Settlement Companies”. Just because one poor marketer went over the line should not mean you lambast an entire industry of nearly 300 companies. Listen to a few bankruptcy attorney commercials….Or any politician on the stump for office!
The logic of keeping high interest rate debt in order to maintain a FICO score is flawed.
Credit to support consumer spending is a naive financial strategy and ultimately results in a low standard of living. FICO scores are simply a formula for banks and insurance companies to optimize their profits with. They no longer have much to do with the true financial stability of a consumer. Live your financial life according to their scheme and you will never achieve financial freedom.
Settlement and Bankruptcy are two very different solutions each with benefits and drawbacks.
Although bankruptcy can provide quick results, it stays with you for life. Every application for a loan, credit, rental agreement, job etc asks “Have you EVER” filed for bankruptcy. Not has it been 3, 7 or 10 years, have you ever. To answer this incorrectly is a serious offense. Many will pay the highest interest rate, charged premiums, forced to make deposits and more for the next 10-15 years. This often results in a cycle of debt that leads back to bankruptcy court. Debt settlement does not go on your credit report like this, and no application for credit, job, home lease or similar asks have you ever settled a debt.
Let’s face it, consumer debt is a result of poor financial management. Consumer debt instruments, short term loans, credit cards, cash advances, credit scores come from the greed of bankers. Debt relief services are the final phase of this cycle cleaning up the mess of a profit. Stop the bankers promotion and consumers psychological acceptance of financing our every day purchases we may be able to break this cycle.
As one that went bankrupt I can tell you your statements about bankruptcy are simply not true. “Many will pay the highest interest rate, charged premiums, forced to make deposits and more for the next 10-15 years. This often results in a cycle of debt that leads back to bankruptcy court.”
People are no more forced to make deposits for 10-15 years as a result of bankruptcy than people with red hair are forced to. And your assertion that it “often results in a cycle of debt that leads back to bankruptcy court” is just plain wrong. The recidivism rate for bankruptcy is extremely low.
Following bankruptcy a person can rebuild their credit quickly. Within two years they can buy a car at low rates and within three years be eligible for a low rate mortgage. In fact, a person that goes bankrupt and gets immediate relief will be done and back to a good credit score before someone in a monthly payment debt settlement program even finishes the program with horrible credit.
As a previously bankrupt person do I have to answer if I was ever bankrupt when asked, yes. Does it impact my ability to have an amazing FICO score and access to low rate credit, no.
The fact that you enrolled with a debt settlement company does not go on a credit report is true, but all the carnage of settling the debt does, you omitted that fact.
On your own site you even say the following about debt settlement:
(1) Late fees, penalties, and interest will continue to accrue on the consumer’s debt until the consumer’s creditors accept and receive a settlement;
(2) A consumer’s creditors may still sue to collect on the debts and garnish the consumer’s wages;
(3) Interest rates applicable to the consumer’s debt may increase;
(4) Any money a consumer saves in negotiating a settlement with a creditor must be treated as income for tax purposes;
(5) A debt settled for less than the full amount owed may result in a negative notation on the consumer’s credit report;
That would put a serious dent in their spin campaign — lol.
.-= Thom Fox´s last blog ..ROR Sitemap for http://www.cambridgecredit.org/ =-.
Another thing to consider is if bankruptcy is viewed as a whole vs. settlements as a singular event. I do not think the original article by Liz Weston made a distinction, but if your score drops for each account settled, someone could wipe out their creditworthiness entirely if they settled 3 or 4 accounts.
Good question. Great minds think alike. I had already put in a call to FICO to get some clarity on that.
I think you’re being generous with your article title. I would have named it “Debt Settlement Companies Make Misleading Statements About Recent FICO Score facts”.
LOL, yes, your title is better.