Before considering defaulting on your secured debt, such as credit card debt, you should do the following:
Step 1. Look at the world from the creditor's point of view. Suppose your boss came to you on payday and said that he couldn't pay you the $10,000 in sales commissions you had earned because he used the money to buy himself a new yacht. He asks you to accept this fact, not complain about it, and to forgive him. Would you accept not getting paid? Of course not! You expect to get paid for your labor and you expect to get paid on payday. You made an agreement with your employer when you began working for him and you expect him to hold up to his end of the agreement.
Suppose your boss continues to refuse to pay you the $10,000 sales commission. You finally get fed up with him and decide to hire an attorney to help you get your money. The attorney tells you his fee is $2,500 and you must pay it regardless of whether or not you win the suit and are able to recover collection costs from the defendant. He also tells you that your employer will likely put up a defense and contest owing you money and that this will drag the lawsuit on for at least 16 months. In any event, your attorney tells you that it will be at least two years before you see a dime, and that's only if you win.
Are you willing to go ahead with the suit? Probably so, and not just because you're angry or need the money for living expenses, but because your attorney told you that there is a very high chance that you will win. You will have to wait a bit for your money, but eventually, you will get justice. So you tell your attorney to go ahead and file the suit. Your attorney sues your former employer for the $10,000 sales commission plus all costs of collection.
When your employer receives your petition, he turns it over to the legal department. The company attorney advises your employer to settle with you because they don't have a leg to stand on. You will most certainly win the suit if it goes to trial. So the company attorney cuts you a check and pays your attorney's fees and all court costs. End of story.
But suppose something else happens when you file suit. Suppose your employer contacts your attorney and tells him that the company is insolvent and about to file bankruptcy. He offers you a settlement of $7,500. Your attorney tells you that the company is filing Chapter 13 bankruptcy and the $10,000 due you will probably never be paid if this happens. Even if you were to get lucky and get something, at most, it would be about 30% of what is due you and that doesn't include your collection costs. And if you do collect, it will be two or three years from now.
Do you accept the deal? Yes, you do if you're smart. Of course, you might counter offer with $8,000 or maybe $8,500 to try and get as much as you possibly can from your employer, but if the employer won't budge, you will eventually accept the $7,500 as payment in full and write the loss off on your income taxes. You would be a tremendous fool not to get what you can at this point in time.
Your creditors think in much the same way that you do despite the fact that they are big organizations that rake in millions every year. What is the only difference? They aren't interested in revenge or justice. You borrowed money from them and agreed to pay it back. They are willing to fight to get the money you owe them in much the same way that you would fight to get the sales commissions that your boss owes to you.
Seeing the situation from the creditor's point of view will allow you to negotiate much more effectively with them. Just as the employer for the example above did, you must present your arguments in terms of what is best FOR THEM and not you. If there is one thing you must remember when negotiating with creditors, it is the following: An unsecured creditor will always choose the option that brings in the most amount of money with the least amount of cost and risk.
Using this rule as a guide, think of what a creditor would due in the following situations:
Situation 1: Joe Smith owes $1,438.56 on his credit card. He defaults when he loses his job and is unable to continue paying on the account. Will the creditor sue? No. Litigating this matter would cost at least $2,000 because they will have to hire an attorney in Joe Smith's location to sue him. Sure, they could sue him and get a judgment for the amount due them, plus all costs of filing suit, but that doesn't mean they will ever collect. A judgment that isn't collectible is a complete waste of time and is too risky, since they have to pay the attorney's fees regardless of the outcome.
What is the option that brings this credit card company the most amount of money with the least amount of cost and risk in this situation? Write off this account as noncollectable and get a tax break and simply recover the loss by raising the interest rates and fees across the board for all customers. Would they negotiate with Joe for a settlement? Yes. If they don't, the debt collection agency certainly will. Chances are this account will eventually be turned over to a collection agency who will try to collect on it for about six months. When they're about to give up collecting the debt entirely, they will send Joe a letter offering to accept 70% of the debt as payment in full. Joe doesn't have to pay 70% because they're about to write off the debt. He can offer to pay them as little as 25% and also demand that they remove any negative information from his credit report.
Situation 2: Same facts as above except Joe Smith owes $5,000 to a credit card company. Will they sue? Probably, unless they know something about you that prevents them from suing, such as that he is absolutely broke, has no assets and is unemployed. If someone is broke and has no job he is considered to be "judgment proof". There is nothing that can be seized, garnished or levied. If Joe suspected a lawsuit was in the works, all he would have to do is start selling off his assets so that by the time the sheriff arrived at his doorstep, there would be nothing or quickly file bankruptcy. You cannot attach wages if a person doesn't have a job. A general rule of thumb is that credit card companies don't go after those they believe are broke and have no assets.
Situation 3: Joe Smith has an excellent, secure, decent-paying job. The only problem is that the IRS is after him for back taxes. They start seizing his property, including his bank accounts and began garnishing his wages. Consequently, Joe can't make the payments on his new car. The Acme Auto Finance Company repossesses his car, sells it for what they can, and plans to come after Joe to collect the deficiency in the amount of $2,500. Will they sue? No, they won't. The IRS is the most powerful debt collector in America. It can seize just about any property it wants and debt owed to it takes precedence over all other kinds of debt. All creditors know that it's a waste of time to file suit against someone who is being seriously pursued by the IRS.
Situation 4: Joe Smith had a nice-paying job for 20 years. It enabled him to buy a respectable $350,000 home, and for he and his wife to always drive late model luxury cars. In addition, he has accumulated an enormous amount of personal property and household goods over the years that he thinks has a total value of $300,000. Despite having a nice income, Joe and his wife could never live within their means. They always wanted more, and so they have 10 credit cards with credit lines of $15,000 or more per card which they used to buy luxuries: clothing, art, jewelry, vacations. They always carried too much credit card debt but somehow managed to keep it under control.
Suddenly, Joe loses his job and he and his wife begin using the cards to pay for basic items like groceries and take cash advances from one card to make the minimum payments on another. They continue to do this for 10 months while Joe looks for work. Finally, the cards are maxed out and Joe doesn't know what to do. If he contacted the credit card companies and asked for relief, would they give it to him?
No! If you don't understand why, then you need to go back to the top of this page and reread it. If you still don't understand why, then pretend like you're a credit card company and Joe owes you $20,000. Would you negotiate with him for a reduced settlement? No, you would tell him to start selling off his assets so he can pay you.
If Joe does not pay this debt, his creditors will turn all accounts with significant amounts over to collection attorneys who will file suit and get a judgment so the creditor can go after his house. Suing Joe is a low risk proposition for a creditor because he has so much to take. Only a Chapter 13 would protect Joe and his wife from these creditors once they take legal action. Filing Chapter 7 bankruptcy would result in much of Joe's property being liquidated to pay off creditors.
When would Joe's unsecured creditors negotiate with him? After he and his wife have sold all of their property except for those items needed to live day-to-day (clothing, dishes, etc.), and then only if they still didn't have enough to pay all of their creditors in full. Joe and his wife might hold a massive auction and sell just about everything they own. They could take the $80,000 net profit from the sale and offer a proportional amount to the ten unsecured creditors that are owed $150,000 as an offer of settlement. They would be motivated to take it since Joe has liquidated all of his assets and there is now nothing they can recover by suing.
Obstacles to Negotiating with Unsecured Creditors
In general, original creditors are always tougher to negotiate with than debt collectors or collection attorneys because --
(1) They haven't given up on collecting the debt yet. They also have a reputation to uphold. If word gets out that they gave in to you, then they will be flooded with customers asking for special treatment. They will negotiate only when they think doing so is the best choice for them.
(2) Their in-house collection departments have certain quotas that must be met. If a credit manager doesn't meet the quota, he risks losing his job or doesn't get transferred to the new location of his dreams.
(3) At least half of all in-house collection departments are headed by females these days. Contrary to what you might assume, female collectors are often tougher and more stubborn than male collectors because they think they have to be tougher to compete in their field.
(4) The people with whom you speak when you contact a creditor often don't have the authority to negotiate debt with customers. They are often poorly trained and simply respond to everything you say with a memorized answer. Their main mission is to get rid of you as quickly as possible, so when you inquire about a new payment plan, they answer with, "I'm sorry, we don't make special payment arrangements." If you ask to speak to a supervisor (and you should always do this if you aren't getting anywhere), they will lie and claim one isn't available or promise that she will call you back later.
(5) Creditors refuse to adopt policies that are in line with national statistics. It is always more cost-effective for a creditor to work with debtors in trouble than to let them default and the account go to collection; yet, few of them will adopt policies that keep consumers solvent. This inflexibility often drives debtors to bankruptcy, where unsecured creditors lose big. Their policies don't really make any sense.
What If A Creditor Won't Negotiate?
If this happens, you must either give up trying to get them to negotiate or let the debt go unpaid until it reaches a new phase in the debt collection process, meaning it is turned over to an attorney or debt collection agency for collection. Of course, this is risky, since you might get sued and have your wages garnished, have to pay collection costs, etc., and doing this will definitely ruin your credit rating.
For these reasons, one should only utilize this technique if you really are on the verge of filing bankruptcy. Perhaps a serious illness in your family has caused medical bills to pile up, or you have an unbelievable amount of credit card debt and don't know how long you can continue making just the minimum payments each month. If you're living paycheck to paycheck, you're in trouble.
If the above is an accurate description of your financial condition, it is only a matter of time before some unforeseen event causes you to fall behind or default on your debts. Perhaps it might be a good time to go ahead and take the plunge and get it over with. How do you know if you are ready to stop paying your unsecured debts? It's simple. If you are willing and able to file bankruptcy right now, then you are ready to take the plunge.
In my next post, I'll discuss tips on negotiating with debt collectors.
BCSalliance.com offers a free online debt negotiation kit to help those negotiate their unsecured debts. Go to kit.