A few days ago, I met a couple from New Jersey looking for financial assistance. As we went over their financial difficulties, they began telling me about this “debt consolidation program” they were in. It was at that moment I knew the reason why they were in my office.
After I explained to them how debt consolidation really works (and rarely works), and how I would be able to really help them get out of their financial mess, the immediate sense of relief was almost palpable. Needless to say, the couple left my office that day feeling relieved and full of hope.
I am still shocked by the amount of people considering debt consolidation over the other more viable options, but I empathize with these people because I too was a victim of a debt consolidation scam in my early 20’s. Unfortunately, the lack of financial education in this country is discouraging as a recent study demonstrates that only 57% of adults are financially literate. To put the proverbial nail in the coffin, this average decreases even further when split by gender and race. My position as an attorney allows me to be exposed to the debt consolidation horror stories that most never hear about. I am here to INFORM the MISINFORMED.
With that being said, how exactly does debt consolidation work?
We’ve all seen the commercials: “If you find yourself in credit card debt – you’re not alone. Support agents are waiting to walk you through the steps necessary to put you on the path to financial freedom! (emphasis on the financial freedom). If you are tired of having a bad credit score (or no credit), and tired of carrying high interest debt – we can help you raise your credit score by consolidating all of your debt into one manageable payment. Call now! And be on your way to financial freedom.” Cut and print scam.
Once you decide to give this Debt Consolidation Company a call, first, they take an audit of your entire debt in order to calculate your monthly payments. After this initial step, you’re offered a “debt consolidation payment plan” which is usually for 3-5 years, with a single monthly payment to be made directly to the Debt Consolidation Company. For example, you have 2 credit cards and owe about $10,000 each for a total of $20,000 in credit card debt. You call the Debt Consolidation Company and based on your debt – they tell you your payments will be $333 per month for the next 5 years. They will say: “All you have to do is make the monthly payment to us and we’ll handle the rest.” The simplicity of it all sounds too good to be true, but the reality is this: 1) it is not that simple and 2) it is definitely not true.
Months go by and you’ve made your $333 monthly payments on time every month. You’re excited because you have a decent credit score (that you expect will increase due to the debt consolidation program). Oddly enough, you start receiving calls from your credit card companies telling you that you are months behind on payments, and if you don’t make a payment soon, your account will be in default and placed in collections (or worse have a lawsuit filed against you). You call the Debt Consolidation Company and they in turn provide you with their cookie cutter response: “It's OK, that’s perfectly normal. Just keep making the monthly payment to us and we’ll address the issue directly with the creditors.”
Here’s the truth that these Debt Consolidation Companies conveniently leave out:
The payments that you have been making on time every month are put into a metaphorical “pot” which is held until you have defaulted on your accounts. At this point, these Debt Consolidation Companies will begin negotiating with your creditors to bring down the balance owed on the account. But why would they do this? This part is simple: They need your accounts to be in default because, if you’re up to date with your payments, there is no incentive for the credit card companies to consider you for an interest reduction or balance negotiation. On the other hand, if you are behind on your payments, creditors are incentivized to work with you so you could keep making payments and keep the gravy train flowing.
How does this translate to a lower credit score? Defaulting on your debt means a lower credit score and your credit score will continue to take a hit so long as your account remains in default. Unfortunately, the only way to take your account out of default is either paying the balance in full or renegotiating the debt - which could take months to do (assuming the creditor agrees).
This should come as no surprise. If you default on your debt, your account will be placed in collections and if the debt remains unpaid, you will be sued for any balance you owe. Debt negotiation is a long process, and credit card companies will continue with any lawsuit filed against you (regardless of whether your debt is being negotiated or not). The lawsuit will move forward and could end up in a judgment entered against you. After they have a judgment against you, the creditor can now take this judgment and have your wages and bank accounts garnished, or have a lien placed on your home. For example, if you own a home in New Jersey, any judgment filed against you becomes an automatic lien on your home.
This is simple math. Sticking with the earlier example, you have about $20,000 owed to 2 credit card companies, and you’re in a 5-year debt consolidation plan with a single monthly payment of $333 ($20,000/60 months). Company A is owed $10,000 and Company B is owed $10,000. You’re a year into the debt consolidation plan and both accounts are either in default or closed. Not surprisingly – your credit score has taken a substantial hit for the last 12 months, but you remain hopeful.
Let’s say that the Debt Consolidation Company is successful in negotiating Company A’s debt from $10,000 down to $5,000 and Company B’s debt from $10,000 down to $5,000. Because the debt consolidation company was successful in reducing your debt down by $10,000, your new “debt balance” should be $10,000, which would also lower your monthly debt consolidation payments correct? The short answer is: NO
Even though the debt was substantially reduced, you will continue to make the $333 monthly payment because the Debt Consolidation Company won’t tell you that the debt was re-negotiated – all you know is that you are contractually obligated to pay the Debt Consolidation Company $333 for 5 years. To put it bluntly: the Debt Consolidation Company was successful in reducing your debt by $10,000 but they intend on keeping any balance of your payments for themselves.
I can’t stress this enough: Any debt that a debt consolidation company can successfully settle or re-negotiate is considered income to you, and subject to be taxed by the IRS. Therefore, not only will the Debt Consolidation Company get to keep any money beyond the re-negotiated debt, (as described above), but you will be the one to pay taxes on any settled or re-negotiated debt at the end of the year.
The debt consolidation commercials are specifically designed to evoke an emotional response and make you feel that the debt consolidation program can render guaranteed results. This is far from the truth.
What they won’t tell you is that some creditors will just not negotiate debt and there is a big chance that you can still owe the debt even after you have made all of the payments under the debt consolidation plan. Don’t believe me? Pick up the phone and give them call – they won’t guarantee results even though they guaranteed financial freedom, and I just don’t see how you can have one without the other.
In my own experience, after having paid over $20,000 in five years in the hopes of financial freedom, I still owed about $5,000 to creditors. At the end of my own debt consolidation plan, not only was I in default with certain creditors, but my credit score was at an all-time low, and I was being sued. Don’t let what happened to me, happen to you.
Let’s recap the entire thing: you’re sitting in front of the TV and you happen to catch one of these debt consolidation commercials – high credit scores and financial freedom right at your fingertips. But wait: 1) you have to default on your credit cards which will ruin your credit; 2) you can and will be subject to lawsuits while the Debt Consolidation Company works on re-negotiating your debt; 3) even if they can successfully reduce your debt, they will keep the difference and your monthly payments will remain the same; 4) not only will they keep the difference, but you will have to pay taxes on the debt that was successfully re-negotiated; and 5) not only are you subject to lawsuits but there is no guarantee that they will be successful in negotiating your debt down.
Trust me – I understand what it is like to be financially up against the wall. I’ve been in your position, and became a bankruptcy attorney so others didn’t have to experience the same financial pitfalls that I fell into. I know that taking on the debt consolidation market is like taking on Goliath. However, if I can get one person or a couple to take a step back and really see debt consolidation program for the scam that it is – then I have done my part to spread awareness and prevent others from being scammed. Goliath did lose after all.
If you are in debt, and whether you need someone to explain the debt consolidation process to you, or if you need to speak with someone about what other options you may have, we are well qualified as a full-service law firm for people in this county and other New Jersey counties: Passaic County, Hudson County, Essex County, Bergen County, Morris County, Union County, and Sussex County. Call us today at 973-554-9827 or toll free 973-832-7643.