I’ve continued to think about my response to David Leibowitz’s discussion of getting out of debt without bankruptcy.  My first response focused on the choices inherent in paying off creditors outside of bankruptcy.

I forgot to point out the efficacy issue:  if you try to pay off your debts via settlement, it takes only one or two big creditors who won’t settle on tolerable terms to undermine the entire effort to repay creditors.  If you can’t get a big creditor to join the rest in compromise, you may have wasted everything you’ve paid out to compliant creditors in an effort to avoid filing bankruptcy.

My favorite story explaining why I don’t attempt debt settlements for clients involves a client who had only two creditors.  Her parents were willing to fund a 50 cents on the dollar settlement if I could get both creditors to agree.  It was obvious that the client could count on filing bankruptcy and discharging the debt.

Over a period of months, I was unable to get just two creditors to buy into a solution that got them half of their debt on the spot.  The client ended up filing Chapter 7; the creditors got nothing.

If you want to pay creditors and be assured of a resolution, file a Chapter 13.  Compel the creditor to accept partial payment.

In short, the weakness of an out of court settlement with creditors is that a real, non bankruptcy solution requires 100% participation of creditors and an absolutely assured stream of cash to pay creditors.

Too often, there are too many things that can go awry in such a scheme, and money is spent on some creditors before the approach craters.

My clients often ask if there is an alternative to bankruptcy.  David Leibowitz, my colleague at Bankruptcy Law Network, outlined what it takes to get out of debt without bankruptcy.  The simple answer is make more money;  spend less on today’s expenses; use all your savings to pay off debt.

I want to pose the question:  even if that’s possible,  is it smart?  What do you forgo in that scenario?  If it’s travel; lattes; and premium cable, I’m OK with that.  But, if what you do without is emergency reserves; health insurance; and retirement savings, I think that a poor choice.

Whether financial difficulty was caused by bad luck or bad choices,  don’t make a bad decision, driven by pride, to compound the trouble by living without a safety net.  Too many of my clients arrive in my office with the conviction that they incurred this debt and, by damn, they want to repay it.  At some level, I applaud that desire.  But what are the likely consequences of repaying that debt if it means making no provision for financial stability now and in the future?

Part of reforming your financial situation involves looking beyond this month’s bills to the needs of the next decade and beyond. Lots of folks got into credit card debt focusing on their ability to make the monthly minimums, rather than on their ultimate ability to pay the debt off.

Particularly in times of profound economic uncertainty, consider the merits of a  fresh start and a plan for financial self sufficiency.

Debt settlement companies thrive on tapping the consumer’s genuine desire to pay back their debts. They promise that they will compromise with your creditors for a sizable discount and all will be well with the world. There are any number of reasons that isn’t so, and the promoters know it, but that’s another blog.

The scheme works because the debt settlement company gets a hunk of their fee first, before creditors are offered a dime. And they get it by automatic withdrawal from the consumer’s bank account. I have been amazed lately at just how hard it is to cancel one of those payment arrangement.

The couple in my office this week are poster children for the absurdity of the debt settlement program. The numbers supplied to the desperate couple, 79 and 76, showed that $19K would go to creditors and $16K to the debt settlement company. Huh?

The other absurdity was that this couple had only Social Security and a small pension for income, and they have a substantial mortgage payment. Yet, the debt counselors(!) wanted $1036/month for this service! Needless to say, the entire arrangement was unworkable and any debt expert worth a $16K fee knew it from the start.

Yet, the firm got several months worth of $1000 bank drafts before the couple’s son learned what was going on and helped extract them from the “program”.

I’ve turned the Florida law firm running this “business” in to the State Bar of California for investigation of unauthorized practice of law in this state. My next task is to see if the money is recoverable.

The Mercury News had a great article on CCCS of Santa Clara County and its president Joy Thormodscard. It reinforces my advice to clients that CCCS is the only credit counseling agency whose advice on alternatives to bankruptcy I trust.

Take a look at their downloadable booklet on Getting Smart About Credit.

Also on point is their input on avoiding foreclosure and on reverse mortgages. Keep up the good work, CCCS.

My blood boils when I read tripe like this pitch from a lender promoting a debt consolidation loan: it’s not a loan, says the headline, it’s a way out of debt. I’m sorry, but that’s baloney.

About sixth grade, I learned that 3+7 and 5+5 both equaled 10. No matter what order the numbers came in, they still totaled the same sum.

Likewise, a consumer is no better off if, instead of having five accounts of $2,000 each, they have one account of $10,000. They still owe $10,000. As my colleague Kurt O’Keefe wrote, you can’t borrow your way out of debt.

My clients, to a man (or woman), want to pay their debts. They are looking for any alternative to bankruptcy. But to call more borrowing a “way out of debt” is like consulting the Humpty Dumpty for financial advice. He, at least, was open that words ” mean just what I choose them to mean”.

I try to dissuade clients from fixation on their credit score as a measure of financial health. I’ve seen too many clients sitting in my office with winning credit scores and so much debt they can’t pay it off in this world or the next. I have to wonder what that score is measuring.

Atlanta bankruptcy lawyer Jonathan Ginsberg writes about the use of credit scores in the insurance industry. I have always found the alleged connection between one’s credit worthiness and one’s safety as a driver to be spurious. Let’s hope the Supreme Court sees this as a pernicious practice as well when it considers Geico v. Edo this term.

Over on the bankruptcy board at Lawyers.com, where I contribute, an Idaho consumer posted a poignant story of engaging a debt settlement company to “get them out of debt”. Using the “services” of this company, the poster now has six judgments of record and two garnishments in process. The debt settlement company, however, has its full fee.

Such stories, and there are lots of them, are emblematic of the profit that debt settlement firms and credit management outfits make on the consumer’s fear of bankruptcy. Most folks will do anything to avoid bankruptcy, either out of ignorance of how bankruptcy works or a moral preference for paying their debts.

Bankruptcy isn’t for everyone, but it would improve the lives of a great many more working families than now avail themselves of a fresh start. Everyone considering paying money to an organization promising to get them out of debt ought to see a bankruptcy lawyer before parting with a dime. Chapter 13 as a debt management alternative. With a handle on the alternatives, there would be fewer of these sad stories.

Cathy Moran
Bankruptcy in Brief

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The IRS’s list of its annual “Dirty Dozen” tax frauds includes credit counseling.

Credit Counseling Agencies. Taxpayers should be careful with credit counseling organizations that claim they can fix credit ratings, push debt payment plans or impose high set-up fees or monthly service charges that may add to existing debt. The IRS Tax Exempt and Government Entities Division is in the process of revoking the tax-exempt status of numerous credit counseling organizations that operated under the guise of educating financially distressed consumers with debt problems while charging debtors large fees and providing little or no counseling.

The debt settlement model heads my personal list of scams, since it so seldom produces any meaningful settlement, provides no protection to the consumer while the money is accumulating, and lines the pockets of the organization in the meantime.

This is the industry that Congress made the gatekeeper to bankruptcy for individuals. Go figure.

Cathy Moran