For many years debt relief plan providers, such as nonprofit credit counselors, and debt settlement service providers, have been seen as two separate and distinct structures in the debt relief services industry. These two sides of the industry have often been at odds with one another. While debt settlement providers have never come together as a unified voice to slam the debt management side, the nonprofit DMP providers have frequently come together (and acted individually), to vilify the concept of debt settlement itself, and later, to call out what they see as bad business practices found throughout the debt settlement side of the industry.
From my view, both DMP and debt settlement service providers get it wrong when marketing and providing their specific debt relief tool.
What follows focuses mostly on the aspersions nonprofit credit counseling agencies (CCA’s) lob at the other side while they actively, yet quietly, attempt to carve out a niche for themselves that would enable them to offer “Less Than Full Balance Plans” or “Credit Solution Plans” – which is just word play for their offering debt settlement (can’t use a term they have vilified for years). I should point out that I have been publicly critical of some of the same debt settlement business practices that credit counselors have taken concern with. I am equally concerned with what I recognize as problematic areas with DMP’s and those who offer them as they attempt to break into servicing debt settlement plans.
CCA’s who interact with consumers who are struggling to pay the bills have been limited to offering DMP’s. It’s traditionally been the only tool in their tool box. The DMP implementation is how they generate revenue from both the consumer on a monthly basis, and from participating banks that offer charitable and tax deductible fair share and grant contributions to the CCA’s as a benefit for enrolling and managing the banks collection function. CCA’s have been, and continue to, lose relevancy in the market place. There are a bevy of reasons for the loss of DMP relevancy and applicability in the market place. Here are just two reasons.
- Banks offer DMP styled hardship payment plans direct to their own account holders which were traditionally the province of CCA’s. Some reports suggest that some of the larger credit card issuing banks have twice as many people they enrolled into internal hardship plans than they have from the credit counselors.
- The recession and job market has created a situation where a DMP, which is designed to offer the struggling consumer payment reduction through interest rate concessions only, is not enough relief for many people to continue to make timely payments. In fact, due to the rigid payment structure of the DMP, more people fail in a DMP than complete them.
While there are more concerns to list as CCA’s fight to maintain a position in the market, the two highlights above will impact the sector if they break into the debt settlement market, and not in an insignificant way given the iterations of the less than full balance plans that would be administered by credit counseling agencies.
The majority of debt management plans administered to consumers are performed by nonprofit entities. These nonprofit agencies are not, in my opinion, typically operated as charities, but as businesses (with some exceptions). These organizations rely on the monthly contributions they receive from consumers who are enrolled in DMP’s. The average monthly payment consumers make to a CCA for administering the debt repayment plan they are on is roughly $30.00. This average accounts for consumers who pay a higher amount and people whose monthly fee to a CCA is cut to zero due to plan affordability. CCA’s then rely heavily on charitable donations from the very banks they are remitting payments to on behalf of their customers. The donation funding from banks have been severely cut across the board over the last several years, but make no mistake, it is still a significant portion of nonprofit agency funding, one many CCA’s cannot envision getting by without, were the donations cut entirely.
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Debt settlement as a means to avoid bankruptcy works when applied to the right person’s financial situation. It works, in large part, due to the flexibilities it affords the struggling consumer.
So, here is what a debt settlement plan, aka less than full balance and credit solutions plans, look like for the bank, the nonprofit debt repayment agency and the consumer:
- Individual qualifications for one of these CCA sponsored repayment plans will be set up using criteria similar to DMP qualifications. There will be credit score and discretionary income and monthly cash flow modeling. DMP plans already experience high failure and drop out rates due to the narrow and strict qualifications combined with the inflexible set up of the payment amounts that don’t allow customers to prepare for emergencies and the fact that setbacks happen. The less than full balance criteria will inevitably follow a similar pattern of narrow guidelines and will suffer from the inflexibilities that are created in the system. So, rather than settlement plans applied to the proper set of individual circumstances maintaining the major advantage of flexibility over a DMP and chapter 13 payments, its bastardized at the expense of the consumer and the economy for the benefit of the CCA so the agencies can maintain revenue and relevancy.
- Consumers enrolling in these types of structured credit solution plans are not solving credit concerns in the manner available to them through a properly designed settlement strategy. Creditors are required to charge off non performing accounts by following GAAP. Charge off of accounts that are not being paid the minimum due in a timely way are treated as liabilities and must be offset against loss reserves in a prescriber period as a result. Banks will charge off accounts entered into these agency plans earlier than customary or on schedule (generally 180 days of not meeting contracted payment requirements). Debtor’s credit scores will get hammered immediately when enrolling in these plans. This is a byproduct of settlement plans and should be expected. No big deal right? Wrong. The full balance of the debt owed will still be reported while making these payments. The settlement will not be updated to the consumer credit report until the final payment is made. If the less than full benefit to the consumer plan runs 48 to 60 months, the individual credit report gets hammered up front, the poor DTI ratio is maintained throughout the entirety of the plan, and the credit gets hammered anew at the end of the plan due to the fresh negatives of settlement being reported 4 and 5 years down the line. This will prevent people from accessing credit markets for home purchases, refinancing, and student loans for themselves or cosigning for children, auto loans and other credit products. Where credit reports are used as a pricing mechanism for insurance products etc., this type of plan will assure maximum premiums are paid for the longest period of time.
Editor Note: Unlike a traditional debt settlement approach where a consumer may settle debts as they progress, the LTFB approach appears to require consumer to make all the years of payments prior to getting full relief of their debts. This statistically increases the odds of default and an outcome that does not resolve the overall situation.
When plans for settlement of unaffordable debts are created specific to the individual’s situation, credit reports and scores can recover sometimes within a year or two, similar to availability of credit to chapter 7 filers. These less than fully beneficial plans being contemplated by CCA’s will cause a doubling and sometimes tripling of the economic effect on the consumers who enroll in them as relates to credit reporting and access to certain types of credit products.
- There are tax implications when satisfying a debt obligation for less than what was owed. If more than $600.00 is forgiven in an agreement to settle debt, the amount forgiven is deemed income by the IRS. Settlement companies have to disclose this. CCA’s will as well. In fact, CCA’s have for years pointed to the tax implications in a debt settlement plan as the reason to avoid them. They rarely pointed out that the IRS allows consumers to apply a solvency test in order to avoid some or all of the tax implications when settling debts for less. They will have to change their tune when offering the less than full balance option. There are problems with how the tax issue can be managed in one of these “light on benefits” plans. In a flexible and strategically creative settlement plan, debts can be settled in multiple calendar years in order to better plan and budget around the tax that may come due for people who are solvent. With LTFB plans, those taxes will likely all come at the same time at the end of a 4 or 5 year plan. People who are unable to maintain the minimum required payments on credit cards are experiencing a financial hardship at that time which increases the likelihood they will be able to fully or partially benefit from the solvency rule and limit the exposure to tax associated with forgiven debt. Given 4 or 5 years to recover while on an LTFB plan (for those who are able to complete one), will likely cause a sizable increase of individuals who will pay the tax in the following year after the debts were settled. This will add a year to a pinched budget.
- Many CCA’s primarily focused on income from DMP’s do have poor customer retention. There are certainly talking points to defer the reality of the high attrition numbers for DMP’s, but those same points will not play well with the dropped and canceled files in a Credit Solutions Plan. In a DMP, the creditor offers to re-age accounts and lower interest rates while the DMP notation for each trade line enrolled appears in the credit report of the enrolled consumer. The DMP notation is removed when the plan is no longer being implemented and sponsored by the CCA. In the LTFB, when the consumer drops the plan, the damage created cannot be unwound. The charge off sticks and all benefits are gone. The full balance of the debt remains and there could be penalties and fees assessed anew and perhaps even retro actively. CCA’s will have to disclose all of these issues upfront to the consumer, but people will forget what they were told, as well as what was read and agreed to later on. It’s a certainty. CCA’s will be exposing themselves to private right of action claims they cannot possibly think of right now. Banks may be pulled into litigation as well. The LTFB plans may create a situation where some state laws that prohibit an account be placed in a negative amortization situation will be breached by people who enroll and drop out in the first several months. This is only one area where state laws and the plaintiffs bar will potentially take action. This same circumstance probably exists now with CCA’s who enroll consumers into DMP’s where the customer drops the plan after making only one or two payments, but to a far lesser degree than would be likely in the same circumstance with CCA sponsored debt settlement plans offered to less than suitable candidates.
- CCA’s will have to disclose to the consumer that the individual can settle these debts on their own for less than what the CCA can do for them. In many instances, settlements will be available for far less. To not disclose this fact will certainly be creating litigation exposures. Banks will be pulled into these actions, I am sure. I have no doubt CCA’s will create an additional conflict of interest when reducing their relationship with their consumer customers down to one of their acting as a fiduciary to the clients they enroll.
Editor Note: But will they inform consumers? I’m not aware that credit counseling companies now routinely tell consumers that creditor internal hardship programs offered directly may provide superior better benefits. This lack of full disclosure creates a problem for CCAs. Are they really operating in a fiduciary capacity and in the best interest of the consumer if they don’t make this information apparent?
- Consumers enrolling into the quasi debt collection scheme of a less than full balance/credit solution plan, who are unable to complete it, do not receive the benefit and protection of laws and rules that govern debt settlement service provider’s business practices today. Recent state and federal laws have been enacted to prevent financial harms to consumers. Settlement companies cannot charge for a service until they have performed. With CCA’s plans to offer a settlement solution outlined above, consumers who pay into the plan that are later unable to continue will be damaged. They will have lost time and money applying a strategy that, when it fails, will find them worse off than before they enrolled in it. In several ways, I can see where the damage will be worse than the upfront fee debt settlement business models that were recognized as so very problematic by regulators and consumer advocates around the nation. CCA’s may be unwittingly creating a situation where the campaign against debt settlement comes back to haunt them in a big way.
- Banks themselves are likely better served by continuing to offer payment options directly to their card members. The larger issuers already offer hardship payment plans that exceed the benefits consumers receive from a CCA sponsored DMP. Banks already offer balance reduction and term payment arrangements to their customers prior to and after charge off. Even if the banks play ball with the CCA’s in a LTFB strategy, they will likely still offer the same plans to the consumers directly. CCA’s will be competing with their financial service industry partners and exposing themselves and the banks to increased risks along the way.
Legitimate concerns are not limited to the bulleted issues above. The realities I have highlighted are each worthy of more detailed commentary. I may cover them in additional articles.
Debt settlement should provide consumers with a flexible and rapid method to resolve unmanageable debts. A good plan puts the consumer in a position to return to responsible spending within 18 to 24 months. The demographic of those who cannot/should not enroll in a DMP, but are suitable candidates to avoid bankruptcy through a debt settlement plan, should be looked at as a large subset of people who can have stimulating impacts on the nation’s economy. Those who can return to responsible spending through chapter 7 discharge and settling unaffordable debts (as opposed to stringing out payments in a DMP, chapter 13 and poorly devised less than beneficial settlement plan), will assist in job creation and economic recovery. This is not an insignificant number of people. The numbers are in the millions.
The current efforts of the nonprofit associations and companies are not the way to go and will lead to little consumer benefit and a fair amount of unintended consequences. I do understand why the less than truly beneficial programs are being designed the way they are. CCA’s are trying to create a delivery system for a settlement option that fits within their collect and pay business model and the laws that govern them. They are trying to figure out what they can do to keep monthly costs of 5 to 10 dollars per customer enrolled in a DMP static with less than full balance plans they can administer. In these efforts, I cannot figure out where consumer benefits come into consideration. I see customer detriments instead. The engineering of the plans appear to first consider what credit card issuers will sign onto, followed by what CCA’s can fit within their current operational limitations, followed by any benefit to the consumer. This is all too evident, and it is bass-ackwards.
CCA’s have a fantastic infrastructure and consumer reach. I have been very supportive of the fact that nonprofit DMP providers should have a debt settlement product/tool available to consumers. CCA’s who are unable or unwilling to build out internal resources should work with other legitimate providers who embrace the educational mission of the nonprofits. There are answers, and options, for credit counseling agencies to pursue in offering a debt settlement tool. The current iterations of less than full balance and credit solution plans miss the mark. I certainly hope this can stimulate a discussion with anyone concerned about debt relief services that benefit consumers, the economy, and the nation as a whole.
Editor note: I’m still stymied that non-profit credit counseling organization are granted their tax status as educational organizations but have they not been actively educating consumers on how to even settle their own debts.
I predict that unless change happens, the liability exposure for not offering education on ALL debt relief options will become a huge liability for CCAs.