by Cathy Pareto

It's never a good day when a debt collector is knocking on your door. Not only is being on the receiving end of debt collection costly, it can be downright stressful and humiliating. Unfortunately for the debtor, creditors can be quite relentless in their pursuit, often peppering debtors with phone calls to their homes and jobs in an attempt to motivate the debtor to pay up in a timely fashion. Debt collectors even have the legal authority to contact a debtor on his cell phone if the debtor included the cell phone number on his application.

Negotiating With Debt Collectors
In cases where the original credit issuer is unable to collect payment on outstanding debts, the process is often outsourced to a professional debt collector or collection agency that operates as an agent of the creditor in exchange for a fee or percentage of debts owed). These collectors are often given some flexibility in offering payment arrangements to debtors. For example, to satisfy debts quickly (and therefore get them written off the books of the credit issuer), debt settlement options like term settlements or final cash settlements are often considered.

When a debtor has reached a point of considerable payment delinquency, the debt collectors may deem the account to be uncollectable and be willing to negotiate a settlement with the consumer. In negotiation with debt collectors, arranging for a full and final settlement of one's debt is often an ideal way to proceed. With this type of arrangement, your debts are fully satisfied without further deterioration of your credit. In a final settlement, you make one lump-sum payment of much less than you actually owe to your creditors in return for the remainder of your debt being written off. A term settlement is similar to a final settlement, but is often staggered over a specific time frame (e.g., six months) and does not provide as much of a reduced debt repayment. (Find out how you can take charge if you're being harassed by a debt-collection agency in Negotiating A Debt Settlement.)

It's worth noting that consumers do have a moral and ethical obligation to repay their debts. The ability to possibly negotiate settlements with your creditors should not be deemed an invitation to irresponsibly run up your debt and then negotiate it away. Every financial decision you make has a consequence, and credit management is no exception.

The Fair Debt Collection Practices Act
Not all debt collection processes are quite so friendly. Despite federal and state legislation prohibiting abusive collection practices, debt collectors continue to abuse consumers in order to unfairly pressure them into paying debts. Abusive or intimidating debt collection tactics are not acceptable and do not have to be tolerated. Consumers do have rights in this matter.

The Fair Debt Collection Practices Act (FDCPA)protects consumers from professional debt collectors who collect on loans they did not originate by using unfair, deceptive or abusive practices. The act technically does not apply to banks, department stores and other lenders who collect their own debts, but no lender is allowed to use such practices.
The following are some highlights of the rules:

  • Debt collectors can contact people other than the debtor only to locate the debtor.
  • Within five days after making contact, debt collectors are required to send written notice informing the debtor of the amount of the debt, the name of the creditor and the fact that the debt will be considered valid unless disputed within 30 days (but only if the debt collector did not provide this information in the initial contact).
  • Debt collectors may not harass, oppress or abuse debtors with threats or obscene language or annoying or anonymous telephone calls, and they may not publicize the debt.
  • Debt collectors cannot make false, deceptive, or misleading claims for the purpose of collecting a debt. This includes the debt collector misrepresenting his identity or lying about the status of the debt or the consequences of not paying the debt.
Violations of the FDCPA can lead to lawsuits and punitive damages on the consumer's behalf. (Learn more about your rights when dealing with debt collectors in Outfox The Debt Collector's Hounds.)

The Bankruptcy Option
Despite the efforts of debt collectors, debtors sometimes cannot or will not satisfy their debt obligations. To get a fresh start, individuals are able to declare one of two forms of bankruptcy: chapter 7 or chapter 13. According to U.S. Courts bankruptcy statistics, 822,590 U.S. families filed for bankruptcy in 2007.

Under chapter 7, the debtor is obligated to surrender certain assets in order to satisfy the claims of creditors as well as costs associated with the bankruptcy. However, specific assets are exempt from the reach of creditors. In some states, your home is protected from creditors under homestead exemption rules. Other major exempted assets include qualified retirement accounts, such as pensions, 401(k) plans, 403(b) plans, individual retirement accounts (IRAs), profit-sharing plans, stock bonus plans, employee annuities and 457 plans. Under chapter 7 rules, most debts are completely discharged in bankruptcy, and the debtor is no longer responsible for repayment. Child support, alimony, education loans and most unpaid taxes cannot be discharged, and the debtor cannot file again for eight years.

Conversely, under chapter 13 bankruptcy, while the debtor is typically not forced to relinquish any assets, the courts will structure a repayment plan to be satisfied within a specified time frame. During chapter 13 proceedings, the bankruptcy judge often will reduce payments and/or debt values in order to make repayment more manageable for the debtor.

While both types of bankruptcy have a negative impact on one's credit report, each has different connotations. Chapter 7 stays on your credit report for 10 years because you are discharging all debts. Chapter 13 involves a repayment plan, so it stays on your credit for seven years.

That said, bankruptcy is really a forever decision because as a consumer (or even as an employee applying for a new job) you are often asked if you have ever filed for bankruptcy, and of course you must disclose that you have because otherwise you are committing fraud. However, it's worth noting that it is illegal for an employer to discriminate against you just because you filed for bankruptcy. (Find out how to determine whether this option will help or hurt your financial situation in Should You File For Bankruptcy?, What You Need To Know About Bankruptcy and Life After Bankruptcy.)

Bankruptcy Testing
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 changed the way consumers can qualify for bankruptcy protection. It used to be that you filed for either chapter 7 or 13 and that was it. This is no longer the case. The credit industry lobbied hard and successfully to have Congress tighten the bankruptcy laws so it would be more difficult for individuals to discharge their debts under court protection. The 2005 act introduced the concept of "means testing," which directly influences whether bankruptcy filers qualify for chapter 7 or chapter 13.

The following are two phases of the test:

  • median income test
  • means test
The median income test used in bankruptcy evaluations is based on the median state incomes published by the U.S. Census Bureau. As long as your aggregate household income is below or equal to the state's median income threshold, then chapter 7 is an option for the debtor. However, if your household income is greater, then you have to apply the means test to determine your eligibility to file chapter 7. For example, a Florida man supporting his family of four faces a state median income of only $68,494 (in 2008). If the man's income exceeds this amount, he would not automatically qualify for chapter 7 and would have to apply the means test.

The means test checks to see if the debtor's current monthly income (reduced by allowed expenses) exceeds an amount allowed under the act for a family of the same size. The means test is basically an "excess income" test used to determine what money is left over each month, to repay unsecured creditors.

Included within the calculation of a debtor's allowed monthly expenses are the following:

  • Standard living expenses.
  • Housing expenses.
  • Transportation expenses.
  • Other necessary expenses, such as child care, taxes, alimony, insurance payments, food and more.
Not sure of what types of living expenses might be considered under the means test? Additional information is available online at the U.S. Department of Justice website, where they publish charts for the National Standards for Allowable Living Expenses.

So, after reviewing the standards for living expenses during the means test process, if the debtor determines that his income either meets or exceeds the threshold income levels, then a chapter 7 bankruptcy will not be possible. Instead, a chapter 13 bankruptcy will be the only available option. It should be noted that any chapter 13 plan must have a minimum duration of at least five years unless the plan provides that all allowed, unsecured claims are to be paid within a shorter time frame.

The Bankruptcy Act's Effectiveness
One other component of the Bankruptcy Act is the mandatory requirement that debtors go through credit counseling and financial management courses in order to qualify for bankruptcy and debt discharge. Counseling must start at least 180 days before filing for federal bankruptcy protection and must be completed with an agency approved by the United States Trustee's office, which can be found at the U.S. Trustee Program website. This particular portion of the act is quite controversial, given that the credit counseling industry is not only unregulated, but is beset with unimaginable fraud and abuse. We'll discuss this further in our next chapter. (Learn more about the 2005 law in Changing The Face Of Bankruptcy.)

While the intention of a stricter bankruptcy code was to dissuade consumers from seeking bankruptcy protection so easily, thus forcing them to be more accountable for their credit decisions, the average amount discharged under chapter 7 bankruptcies actually tripled to $61,000 between 2005 and 2008. The number of personal bankruptcies has also increased since the Bankruptcy Act took effect. According to the Administrative Office of the U.S. Courts, personal bankruptcies were up 25% in the period from June 2007 to June 2008 when compared to the previous year. These statistics offer a true testament to the dire financial position many Americans find themselves in.

Find out how to avoid this financial move in Prevent Bankruptcy With These Tips.



Next: Credit And Debt Management: Credit Counseling »



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