no third solution

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Credit Card Scams Part I: Debt Collection Practices

June 16th, 2008

Updated: This began as a single post, but started the thought process on a series of scams perpetrated by credit card companies.

  1. Debt Collection Practices & Impropriety
  2. The Reverse Payment Prioritization Scam
  3. The Balance Transfer Scam
  4. The Penalty Rate Scam
  5. Exploiting Ignorance: Money for Nothing

A recent article in Business Week highlights some apparently (IMO) improper practices used by credit-card issuers in collecting debts. Most of them use one of several private arbitration companies. The Business Week article, Banks vs. Consumers (Guess Who Wins?) implies that the National Arbitration Forum is probably up to no good and cites a number of business practices that lend (no pun intended), at the very least, the appearance of impropriety.

What if a judge solicited cases from big corporations by offering them a business-friendly venue in which to pursue consumers who are behind on their bills?

…[T]hat’s essentially how one of the country’s largest private arbitration firms operates. The National Arbitration Forum (NAF) … specializes in resolving claims by banks, credit-card companies, and major retailers that contend consumers owe them money. Often without knowing it, individuals agree in the fine print of their credit-card applications to arbitrate any disputes over bills rather than have the cases go to court.

Of course, most of the article is circumstantial fluff, that could very well be taken out of context or could be outliers to reality. I do, however, find it alarming that NAF rules in debtors’ favor only 0.2% of the time. That number strikes me as exceedingly one-sided. Then again, the creditors routinely dismiss arbitrators who are known or assumed to be unbiased debtor-friendly.

One former arbitrator for NAF “said that after she awarded a consumer $48,000 in damages in a collections case, the firm removed her from 11 other cases.”

…”[B]oth sides in each case have the right to object to one arbitrator suggested by NAF, based on the arbitrator’s professional biography, which is provided to the parties. Creditors had simply exercised that option with [that arbitrator.]”

Of course there is some serious assymetry here: the creditors see hundreds or thousands of cases; they have the information necessary to dismiss anyone suspected of not handing down favorable judgments.

The article also mentioned that creditors like to tack on fees for hunting down delinquent debts. What the creditor is saying, is that “You have defaulted on your debt, so I am going to (in a pretty arbitrary fashion) declare that you owe me more than you really do,” in order that you pay them more money. What I say, is that the creditor should have already priced the risk of default, and charged the population of its debtors a sufficient aggregate interest rate to cover that risk profitably.

Creditors make money on the fact that most people do everything they can to avoid default until its the only option available. When they miss payments, they are assessed late payment fees, and/or a penalty interest rate. This means that for many months, sometimes years, they make the bare minimum payment. Assessing fees for the collection of past-due debts strikes me as unconscionable, primarily because (and this may be semantics) the default risk should already be provided for in the interest rate charged on the debt.

My hypothesis, unfounded as it is, is that creditors are preying on most people’s willingness to honor their agreements, they know that most people will continue to try and pay the debt as assessed, and eventually when a compromise is struck, it will be determined on the basis of the higher balance including the spurious fees and penalties. I suppose debtors “agreed” to this in the fine print, but in practice, by the time an account is delinquent enough to be handed to a debt-collector, hundreds or thousands of dollars in late fees and penalties have already been tacked on to the amount due. The borrower has defaulted on an unsecured line of credit. Creditors at this point should be pretty much out-of-luck.

Let’s look at an example. I’ve heard that the average debtor has something like $10K in unsecured credit card debt.

Someone with a $10,000 balance, and an interest rate of 17.99%, assuming a minimum payment of accrued interest + $20 will have a minimum payment of $170 due. Assuming they can afford to pay the minimum plus an additional $50 in principle, over the course of a year, this individual will have paid $2,570 to the creditor, but he has reduced his balance due by only $770. At this rate, it will take him 12 years and $21,000 to pay off his balance. If the individual is really aggressive in his payback plan, eats nothing but Ramen noodle, walks to work, and doesn’t miss a payment, he might pay something like $500/month. At the end of the year, he has paid $6,000 in order to reduce his balance by $4153. At this rate, it takes him 24 months and $12,000 to pay off his balance.

If, on the other hand, this individual misses a payment halfway through the year, and is assessed a modest late fee of $50 and a penalty interest rate of 24.99%, at the end of the first year he has paid approximately $3002 to his creditors, and has only reduced his balance by $498. When you really break it down like this, I think it’s in the debtors best interest to tell the credit card issuer that you are simply unable to pay back that debt, please destroy my credit and never call me again. It’s probably easier to deal with whatever happens to one’s credit score, than it is to spend 12 years trying to pay off that debt.

These problems are compounded by the fact that (in Michigan and I presume in other states) unsecured debt is really quasi-secure. If debtor defaults on a credit agreement, the creditor can, at its discretion, seek a default judgment in a state court. Such a judgment can be filed with the register of deeds in any county in the state, and acts as a valid lien upon real property the debtor owns or comes to own subsequent the date of judgment. Such encumbrance will prohibit the debtor from realizing capital gains on the sale of real property up to the amount of the lien, or from refinancing to take cash out of an equitable position.

I don’t really have a whole lot of advice to offer people in these situations, but I’ll give it a try:

Unfortunately, you probably have to declare bankruptcy in order to repudiate debt like this. You can walk away from a secure debt like a mortgage, but I’m not sure you can walk away from the debt on your Best Buy credit card. The creditor will probably garnish your wages (can they do this?) or file a lien against your real property (jurisdiction permitting).

My advice would be to 1) immediately destroy the card, cash advance checks, etc., call and cancel the card. This is difficult to do, because they don’t want to lose your revenue stream. Resist the offers of 0% balance transfers for six months (to be discussed in greater detail in a subsequent post). Resist any offers to keep the account open. You will probably be transferred to three or four individuals, each of whom will give you greater resistance. Cancel the card. Then establish a budget for yourself, and a repayment schedule (this will be daunting). If you have a good credit history, you may be able to work something out with the creditors. Tell them that you are trying to pay off your debt but given current conditions are unable to. At the end of the day you are dealing with people, not robots, treat them politely and ask for concessions: a lower interest rate, a compromise on the balance due, etc. If you can take out a consolidation loan, do it, but under no circumstances should you take out any additional advances, open any new lines of credit, etc.

no third solution

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