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Debt Settlement Companies Draw Wrong Conclusion About Recent FICO Score Facts

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.”

FICOThat 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.

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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.

Sincerly,
Steve

You are not alone. I'm here to help. There is no need to suffer in silence. We can get through this. Tomorrow can be better than today. Don't give up.





About the author

Steve Rhode

Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.

21 Comments

  • 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.
    http://www.tipsforinvesting.ne

  • I think this is a fantastic topic and truly deserves much more focus by media and consumer advocates.

    Due to:
    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:
    http://debtbytes.consumerrecoverynetwork.com/debt-relief-options-vs-your-credit-score/

    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.

    Also:
    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.

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