The following guest post was contributed by Michael Bovee of Consumer Recovery Network.
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First of all, let’s establish that debts get settled for less than the balance as a matter of course. Issuers of unsecured credit cards do accept less than full balance settlements as payment in full and will continue to do so. Anyone not aware of this fact is just not paying attention.
The reason settlement is attractive to creditors as a means to resolve a delinquent account is due to the fact that it will often be the option available for the banks to lose the least amount of money.
An account must be delinquent in order to achieve settlement.
It must be understood that settlement typically will not occur unless a creditor is approaching or has passed the time requirement to recognize a loss on the full balance of the unpaid debt. This is generally referred to as “charge off”. You have to fall behind. There is generally no way around this fact.
The ideal debt settlement candidate may not qualify for a DMP and may wish to avoid bankruptcy. Creditors benefit from consumers opting for settlement as opposed to their account holder filing for bankruptcy.
Creditors receive nothing 90% of the time in a chapter 7. Creditors receive what the bankruptcy trustee allows them in a chapter 13, which is quite often less than 60% of the full account balance.
Creditors know there is a 70% historical likelihood the consumer will not complete the chapter 13 repayment plan. Creditors understand the real time value of money and see wisdom in accepting a portion of soon to be, or already written off balances now, as opposed to the chance of recovering maybe 60% over a 3 or 5 year chapter 13 plan, but only roughly 30% of the time.
There are costs associated with collecting.
The following is from an article I published in 2009. It is simplified to show the math creditors have to work with when your account goes seriously delinquent.
Once an account becomes seriously delinquent, the odds of ever being paid another penny on it decrease dramatically. Creditors have the option of accepting less than the balance in satisfaction of the entire debt, or drop the account into the collection pipeline and see what they get on the other end. This pipeline consists of 3 options; assign, sue or sell, or what I jokingly refer to as A-S-S.
Assigning your debt:
Assignment collectors are companies who, on behalf of the creditor, are attempting to collect on unpaid balances. Generally, whatever they collect, they are paid a percentage. Credit card issuers will grade the performance of those they assign debt to and will continually award collection files to the best performers, the companies who get them the most money. Assignment of debt also has different tiers. You may be contacted by one debt collection company for a few months, then a different one after 90 days, and even another one 90 days after that. The collector’s job is to get as much as they can for their client, the bank, and to secure the best return for themselves on their performance based fee. Assuming the collector is able to collect 50%, the creditor may see a return of as much as 35% of the assigned balance. This number is a moving target, and will likely be different per account, per portfolio, per tier, per creditor.
Being sued to collect your debt:
Creditors select accounts for immediate referral to law firms in order to collect. Some law firm’s collection attempts will be very similar to an assignment collector where the firm is paid a performance fee just like assignment collectors. Others may start off with that appearance, but will then begin legal process in order to collect. Attorneys who sue in order to collect will generally add legal fees to the final judgment amount. Most law suits for unpaid credit card debt go uncontested and default judgment is entered against the debtor. The judgment itself is a piece of paper, but with legal enforcement implications that allow for collection of the debt via lien, levy and garnishment. Filing suit has its own costs that will vary, with no guarantee the judgment can be collected on. For your creditor, this means higher cost’s with an unknown return (rest assured the return as an aggregate justifies the expense enough to keep this part of the pipeline in tact-otherwise it would no longer be supported).
Selling your debt:
There are different tiers of debt sales. Your account can be sold several times and will have a different value at each sale. I want to focus on the sale done by the original creditor, who you opened your account with. Several years ago, while attending a collection industry seminar, I sat down briefly with a VP of risk management for the now defunct WAMU, who told me at that time, WAMU was catching bids of 15 cents on the dollar for freshly charged off debt (that number was consistent with the daily updates I was seeing from industry newsletters I receive). Charge off generally means the creditor is no longer expecting to be paid and is recording the debt amount as a loss. That was then and this is now. In the current economy, portfolios of fresh charge off debt are being bid at 5-9 cents per dollar.
When your debt is purchased, the buyer will then subject the accounts it purchased to the A-S-S principle described above. The buyer has risked their capital with an expectation that they will be profitable by making an ASS of themselves. Sorry, couldn’t help myself.
Historically, the percentage of non-performing credit card assets has been low, less than 5%. In today’s economy, that number has skyrocketed to all time highs. Default on mortgage debt, commercial debt, revolving unsecured consumer debt (credit cards) are all approaching, or have surpassed any prior precedent.
Focusing on unsecured credit card debt; how has all this affected settlement? Well, look at the math. Your creditor will often “lose the least” be reaching agreements with those in serious delinquency before they drop it into the collection pipeline. This is why settlement works, whether 10 years ago or today.
With these increased portfolio losses at all time highs, banks would prefer to work with the consumer in order to lose the least. Consumers, whose financial situation suggests settlement is a good option to pursue, will find by working directly with their creditors they will often be in the position to save the most.
There are a few of the larger card issuers with whom the best savings will not be achieved until the account is placed with outside collection, but for the most part, reaching an agreement with the original creditor is in the best interest of the bank and the consumer.
So, this shows that settlement on delinquent accounts is not just a good option for consumers to avoid filing bankruptcy, but is also a good option for the banks to recover a better portion of non performing accounts that pass a certain level of delinquency.
What Many Debt Settlement Marketers and Professionals Do Not Openly Talk About
Debt settlement service providers have for years been able to charge fees prior to accomplishing settlements for their clients. Upfront fee abuse has been dramatically curbed by recent federal laws banning the practice. The advance fee ban went into effect on 10/27/10. Prior to the ban, the fee collection methods used by the vast majority of the debt settlers had a major impact on the timing of settlements and creditor behavior. The fees being charged by industry meant very little debt was being settled with creditors prior to charge off. The debt settlement service providers settled the vast majority of accounts (when they did settle) with 3rd party assignees and/or debt buyers.
Creditors could clearly observe the debt settlement industry and see that the services were being heavily advertised and likely to many of their card members who may have otherwise been able to pay, but had viewed some commercial suggesting there is a way to not have to. Most of these commercials boiled down to “call toll free and get out of debt for less than you owe”. Some of the commercials were far more brazen with claims of “settle for pennies on the dollar” & “get your piece of the bailout”.
Major issuers of unsecured credit cards began to take a hard line and refused to work with settlement companies directly. Many still won’t. Was it the commercials, or the math that led to their hard line stance? Probably both, but the math would be what I identify as the larger of the two motivations. Debt settlement has for the most part been done at the largest expense to the creditors when done post charge off and when considering the design of the professional debt settlement service until the FTC stepped in.
Perhaps the debt negotiation industry will be able to repair the damage it allowed to be done by its prior fee grab mentality. Creditors with the hard policies of not working with 3rd parties in settling debts may soften their stance knowing they are getting paid first and the service provider is paid after the deal is struck and at least partially funded. The changes made by federal regulators being less than 6 months ago, I have not seen much change to date.
You Need to Know
Creditors have had internal policies to work directly with their card holders who reach advance stages of delinquency and have been settling direct with consumers for years. The math supports their effort in doing so. In many instances you will actually get better savings results by settling prior to charge off than by allowing the account to fall into the collection pipeline. If you’re working with a settlement company and they are unable to work direct with one or more of your creditors they will be forced to wait until after charge off to work the ASS principle I described above. Will this cause you to miss out on opportunities? Yes. Are the missed opportunities worth you’re having someone else taking care of the accounts? Perhaps.
If you have a simplified situation where there is only one or two account in default, debt settlement will be a pretty straight forward process for you. You could in fact start a thread on the debt settlement forum section on this very site and get assistance in navigating the process on your own from start to finish. If you have 2 and certainly more accounts, you could likely benefit more from personalized strategy designs delivered by a pro that will be able to help you prioritize your debts by creditor, creditor concessions, timing, funds availability etc…
There are intelligent designs with creative and flexible approaches that will optimize your success with a settlement and negotiations. Few companies have used them. They will need to get up to speed quickly because the fee model now used by any reputable settlement company means they only get paid for results. Those results will now be sought earlier than had been the industry norm.
Debt settlement is not rocket science. There is a science to it, but it consists mostly of timing, funding and a short list of to do’s and a longer list of not to do’s. Once you learn the fundamentals you only need to know what your specific creditors are doing by way of policy and what those in the collection pipeline are doing at the time settlements are sought. The creditor policies and third party collection process is fluid. Changes are frequent and account treatment is unique from one consumer to the next. Settlement and concession decisions can be driven an affected by things that are unique to each person in debt. It’s the fluid part of the settlement process that points to working with a reputable professional as a prudent step to take for those with multiple accounts.
If you are wondering how you may be able to avoid bankruptcy by settling debts instead, I would still encourage you to start a thread in the debt settlement part of this sites forum and get some direction and free help from pros in the field.
You can also look to consult one on one with a member of the AACC who offers a debt settlement service. They all provide the ability to speak with them directly for no cost or obligation.