So, you are considering a Debt Consolidation Company (DCC) as part of your financial plan? Here is some eye opening advice to follow before taking this important decision. The idea of somebody else handling your money might sound appealing to some, but in this case out of sight, out of mind might not be the best strategy to modify your mindset and get you closer to financial independence.
Let’s explore how most Debt Consolidation Companies work. The DCC provides you with a representative that will interview on how many credit cards you have, current interest rates and outstanding balances. Most likely they will inquire to some or all the Credit Reporting Bureaus, starting the “hit” on your credit score. After the debts are identified, the company will request you to open an account in which you will make your consolidation payments to. First thing that gets paid out of this account is the DCC fee. As they accrue a substantial amount on this account, they tell you that they are in the negotiation process with your cards, and they advise you not to pay any cards. You fall delinquent for nonpayment, establishing another hit on your credit score. Meanwhile, you keep paying up the account that was set up by the DCC. After you have deposited a fixed amount in the account, which by the way will cover the DCC fee first, then they will start negotiating with your creditors. It is important to know that the only way a credit card account is up for settlement for less than what is owed, is because the account is late in payments. At this point, your credit is ruined for non-payment of your obligations and the credit card company will start to negotiate the debt with the DCC on your behalf. But the story doesn’t end there, here’s where Uncle Sam will catch up with you.
As an example, you have a card where your principal balance is $5,000. You do not pay income tax on the $5,000 because it is not income; when you did your purchases you understood and had every intention to pay back the credit card. Life happens and you can’t pay your balance and you approach a DCC to help you with the problem. They set up your account and tell you that you must pay equal monthly payments of $218.75 for eight months (Total of $1,750). Of that amount their fee is 15% of the debt negotiation (about $750 which they will cash immediately), the remainder $1,000 is all they are negotiating to pay to the credit card company. Now let’s say the DCC is successful and the credit card company stops attempting to collect the debt from you. The settlement on your $5,000 is $1,000 plus what you have already paid to the DCC as their fee, $750. Now, the credit card company has to balance their books, right? So they effectively forgave you $4,000 and somehow will have to report this as a loss. Any forgiven debt that the DCC negotiates for you will typically be counted as income and will be subject to taxes. At the end of the year, when you thought all was fine and dandy, you will receive a Form 1099-C from the credit card company that will show the negotiated settlement amount and you will be responsible to report the “savings” as income in your tax return.
Now let’s run the same scenario on your own. If you are late on your payments and have cash at hand, it is often possible to negotiate terms, interest rates, and payments on credit card debt on your own. You must make it a job to call these credit card companies often. Jot it down on your agenda and call constantly (minimum twice per week). It is not difficult, it only takes determination and patience to get over this hurdle. Let’s say you have the same $5,000 balance debt as above. First thing you have to get clear with the credit card is your intention to settle the balance and the need that you have for them to stop the accruing of interest on this account. Let’s say you have been able to save the same $1,750 as the example above. Now this quantity can be applied all to the principal in a settlement. Offer the credit card company this money if they are willing to provide you in writing a settlement letter on this account. Never, under any circumstance, give electronic transfer access to the credit card account or pay them the settlement amount before receiving a letter from them listing the terms agreed on your settlement. Once you get the settlement letter, pay off the account and make the note “Paid Settlement in Full” on your personal check or cashier’s check, never pay by Electronic Transfer Fund (ETF). This way when they cash the check, you have a paper trail to substantiate your payment. Please note that this scenario won’t save you from Uncle Sam either. You will be getting a Form 1099-C for $3,250 that you will have to report as income on your tax return, that’s $750 less that you have to pay income tax on from the scenario above.
You can also try to negotiate a settlement of the amount you owe directly with the credit card company. This scenario is not likely to yield forgiveness of the debt but I encourage you to try nonetheless. The steps you take and the options available will depend on your situation and on the credit card company that you are dealing with. Be forewarned that the credit card company may not be willing to entertain or negotiate a credit card balance debt settlement if you are in good standing. In that case you might consider settling for keeping the principal debt but closing the account to stop the accruing of interest.
The best advice I can provide you with is to aggressively pay off the balances until they are paid in full. This scenario avoids the tax consequences any settlement trigger and will help keep your credit score build good standing. There are several ways to do this and I can help you devise the best plan for you and your family. Contact me by email at email@example.com to set up an appointment and devise a plan to get rid of your credit card debt once and for all.