As if to affirm this new era of frugality, new data from the Federal Reserve suggests consumers have cut up their credit cards and paid down their debts. According to the Federal Reserve, Americans carried $806.9 billion in credit card debt during the second quarter, down 9% from $887.1 billion during the same period last year.
But hold back the bubbly. A quirk of the banking rules has made consumers’ balance sheets look better than they actually are. In reality, says CardHub.com, people haven’t paid off their credit card debts – banks have simply written them off the books. It’s the accounting equivalent of being disappeared: The bank writes off any debt that’s more than 180 days past due, meaning the consumer has made no payments for 6 months. The borrower still owes, but the debt evaporates off the bank’s balance sheet. And because the Fed relies on those balance sheets to calculate outstanding consumer debt, the practice artificially deflates the “official” figures.
According to the Fed, consumer credit card debt fell by $12 billion during the second quarter. But during the same period, banks reported $21.8 billion in charge-offs. So consumers actually accumulated an additional $9.8 billion in credit card debt, according to CardHub – 250% higher than the debt increase in the second quarter of 2009.
Here’s what consumers who have missed one or more credit card payments need to know:
Seek help immediately
Consumers who find themselves falling behind should start by meeting with a nonprofit credit counselor and a bankruptcy attorney. Many people wait too long to consult a bankruptcy attorney, says Gerri Detweiler, a credit advisor for Credit.com. Meeting with a debt professional “will help you understand your Plan B and your Plan C,” she says. Consumers who can say they’ve already consulted professionals will also be in a stronger position to negotiate with their lenders, she says.
Make a debt management plan
Borrowers who can make their minimum payments should consider debt management plans, which are less damaging to credit scores than debt settlement or bankruptcy, says Odysseas Papadimitriou, the chief executive of CardHub.com. Credit counselors can also help create a plan like this, which typically involves a reduced interest rate and an easier payment schedule, but no overall reduction in the amount owed.
Be wary of debt-settlement offers
In the past, debt-settlement companies have been a trap for consumers more than often than a helpful service, according to the Center for Responsible Lending. Many of these companies charge up-front fees and encourage clients to deliberately skip credit card payments, leaving consumers deeper in trouble with creditors, and out substantial sums of money, before it’s clear whether the company will ever achieve anything on the client’s behalf. More than half their clients end the relationship without any relief (often because they’ve had to file for bankruptcy). On the whole, consumers have suffered a net loss from working with debt settlement companies, according to a report prepared by the center.
As of Oct. 27, a new FTC rule will prevent debt-settlement companies from charging any fees until they actually win a consumer a debt reduction or another new deal with a creditor. Consumer advocates say this shifts the balance somewhat in consumers’ favor, but it’s still better to negotiate a settlement directly with a creditor. “Why pay for something you can do for yourself with your creditor for free?” says Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling.
Negotiate a settlement if you need to
Because banks have had to write off so much consumer debt, they’re increasingly willing to negotiate settlements. These days, many people who are between 30 and 90 days past due will get a call or a letter from their bank offering a deal, Detweiler says. At that point, it’s still wise to consult a bankruptcy attorney before agreeing to an offer, she says. And of course, consumers can also initiate this conversation themselves.
Consumers working out a need to get a letter on the bank’s letterhead that confirms the payment amount will satisfy their debt in full, Detweiler says. If a bank forgives more than $600 in debt, they’ll send the borrower a 1099 form stating the forgiven debt as income. So consumers settling debts should consult a tax attorney before completing a deal to ensure they can get income tax waived on that amount, Detweiler says.
Keep emotions out of it
When coping with credit card delinquency, it’s important to remember that it is possible to rebuild credit, Cunningham says. When speaking to a bank representative, keep in mind that they’re likely following a script, “so don’t take anything personally,” Papadimitriou says. “Don’t feel overwhelmed talking to them, they are not going to be judgmental,” he says.