Understanding Debt

We get into debt when we borrow money we don’t have for things we want before we can save for them and pay cash. That’s how the credit card industry occurred. Lenders started giving credit to worthy borrowers back in the cowboy days. Over the decades, it has become the largest business in the world.

Lenders started giving credit to worthy borrowers back in the cowboy days. Over the decades, it has become the largest business in the world.

Let’s look at the automobile as a prime example of getting into debt. With the cost of vehicles today, there are only a small percentage of people who can afford to pay cash for a vehicle. The rest of us ask a lender to provide financing for us. We put a minimal amount down, and we make monthly payments.

Let’s look at the automobile as a prime example of getting into debt. With the cost of vehicles today, there are only a small percentage of people who can afford to pay cash for a vehicle. The rest of us ask a lender to provide financing for us. We put a minimal amount down, and we make monthly payments.

For the lender must make a profit lending us his money. So he offers a percentage interest rate that is applied to the balance due, split up into monthly payments over time. If you agree to his offer, you sign the papers and you drive away. The lender is taking a big chance that you will honor your commitment, and pay him back as agreed. That “chance” he is taking is called a “risk factor”.

You are graded on your credit report based upon your history of borrowing and paying back. This grade is a number that the bureaus apply to you. This numbered system indicates how much risk a lender is taking in allowing you to borrow from him. He will make a decision to lend you money to pay for the things you want based on this number. He may make a decision to lend money to you even though you may not have the highest credit score, and to offset his added risk, he may charge a higher interest rate.

If you run into financial trouble during the length of your loan, and you begin making late payments or skipping payments, you are considered “in default”, and the lender must act to mitigate his risk or take back the property. Some of the ways risk is mitigated include:

• Higher interest rates
• Financial penalties including late fees and over-limit fees
• Ultimately, if the loan is not caught up soon, foreclosure or repossession is an option for a lender.  Foreclosure means a legal process whereby the vehicle can be repossessed by the lender. As the borrower, you do not get to recover any of your payments, because you were paying for the use of the vehicle.

It is very important for you to understand the basic differences between a “secured” loan, such as a car loan, and an “unsecured” loan, such as a credit card.

Simply stated, a “secured” loan means that you promise to give back the property if you can’t pay, and the property has to be in good working order similar to when you received the property. You will not get any of your money back in this situation.

An unsecured debt, like a credit card, means that a lender agrees to allow you to borrow at will without any security or collateral to back up the loan. A lender will give you a credit line up to a certain amount. As long as you don’t go over the limit and pay your bills on time, the lender is happy because he is making money every month on the loan. Remember, the lender is paying out of his pocket, in advance, for you to get what you want. If you do not pay him back in full, within the length of the loan, then he may not easily get his money back. He trusts that you borrowed the money “in good faith”, and that your intentions are pure. He knows that may not be the case, so in these cases, depending upon your credit score, he may apply a higher interest rate to these types of loans. You agree when you get the credit card that if you do not pay on time every time, at least the minimum amount he requires, you will be in “DEFAULT”.

The agreement you sign gives him the right to sue you in court to recover his money, including interest, court costs, and attorney fees.  If he is successful, and he usually is, you will have a default judgment against you.

It is important that you understand what that means.  Getting a default judgment against you means that the court gives the power to your creditor to do three things to collect from you legally, and none of them are pleasant:

1. Wage Garnishment.  The creditor’s attorney will ask the court for a warrant, and serve that warrant on your employer, called a “garnishment”.  A wage garnishment means that your employer is given a court order to withhold certain amounts from every paycheck you get until that debt is settled.  The amount can vary by state, but most states allow about 25% of your take-home pay to be withheld, and then sent to the creditor as partial payment of the debt.  There is no way out of this unless you quit your job.
2. Bank Account Seizure.  The creditor’s attorney will get a court order to seize your bank accounts.  This means that a court order is given to your bank that compels them to freeze your account(s) for 30 days.  If you have automated payments and/or automated deposits scheduled, none of those things will happen during the freeze, making it difficult for you to keep up with your bills.  If the bank finds a checking account with just one person’s name on it, and all the money going into that account is from wages, your bank will be compelled to give your money to the creditor at the end of that 30 days.  However, if the account they find is a joint account, and your spouse is not named on the lawsuit, and you do not live in a community property state, then the creditor can’t take the spouses contributions, nor can they take social security, disability, SSI or pension money…those funds would be released at the end of the 30 days.
3. Property Lien.  If you own your home or other real property, the creditor’s attorney can place a lien against it.  This means that a piece of paper is put with your title documents saying you owe this money, and you will not be allowed to sell the property or transfer the title as long as the lien remains unpaid.

This is a lot of power given to the creditor.

Understanding Collections

Collections is a word that has many different definitions. In the context of “to collect a debt owing”:  When we get behind in our bills, these are some of the things that will occur:

1. Lender Collection – a collection department within the lender’s operations may make calls to us, write to us, and threaten legal action if we do not resume paying as we agreed. Sometimes a lender will be understanding for a short time, and seem nice to you. But as time progresses, they can decide to hire an outside debt collection firm to contact you.
2. Hired third party collectors – a lender can hire a third party collection company to collect for them. Sometimes this is a company and sometimes it is an attorney who specializes in collections. A hired third party may begin threatening legal action against you, but they generally have a set period of time that the lender is willing to give them in order to collect from you. If they are unsuccessful, they will return the debt to the lender. At this point, the lender must decide to charge off the debt or begin legal action.
3. Charging off the debt – internally, the lender can “charge off” the debt, which means writing it off and using it as a loss for tax purposes. They may also have insurance to help them recover some of the loss. However, this does not mean that you are off the hook. It simply means that for the present, the lender is claiming a loss. You still owe the debt.
4. Sell debt to a Third Party debt buyer - which is a company, sometimes a collection agency, a private debt collection law firm, or a private investor that purchases delinquent or charged-off debts from a creditor or lender for a fraction of the face value of the debt based on the potential collectability of the accounts.
5. Legal Action – starting legal action can take one of two paths:
   1. Small claims court. Each state has a limit to the amount that can be sued in small claims court. This court is the simplest for them to get a judgment against you. The cost of filing is small, and the lender will usually win. You generally may not have a defense against this type of claim. You may be fortunate enough in talking with the attorney at the hearing to have him offer you a settlement. You may not need attorney representation for this type of court action.
   2. A lawsuit in district or superior court. This type of action can have similar consequences as in small claims court. The difference is the costs involved. The court wants you to consider having a lawyer on your side to protect your rights which costs you more money. This kind of case is nearly always decided for the plaintiff (lender), and you will have to work out some kind of payment arrangement with the lenders attorney. Sometimes you can set up a payment program over time. Sometimes you can get a lower balance agreement if you can pay in one lump sum within a specified period of time.
6. Original Creditor Sales of Debts: most of the time, creditors/lenders decide to write off the debt and sell it to a third party collection company. The collection company pays pennies on the dollar for the debt, and once they have control of it, they begin debt collection attempts to recover the whole debt. They may even sue to recover the balance owed.

It is important to understand banking law and how it affects you.  When you stop making payments, the credit card company puts you into a state of default.  For the next six months, they are required to do everything in their power to get you back on track with your payments.

When they are unsuccessful doing that, most people don’t know that they are required by banking law to make a decision right then about your account:  1)  write it off and take the loss; or 2)  put this debt into their non-performing category and pursue it through the courts.  They look at your credit report, and other reports they have available to them, to determine if you have any assets that they can get hold of.  If they think you do, then they may decide to sue you to recover at least part of the debt owed.