New on FinoLib · Volume V: Personal Finance
New on FinoLib, my finance education website: I have published an article called Debt Collection and Bankruptcy: What to Do When You Can’t Pay, from Volume V: Personal Finance. It is part 1 of a 2-part guide. Here is what the article explains, written as a short expert briefing; the full piece, with every worked example, is one click away.
The idea in plain words
If you can’t pay a debt, the worst move is to ignore it. Act early and in order: call the lender, then talk to a nonprofit credit counselor, and if the debt could not be repaid in about five years, speak to a bankruptcy attorney or legal aid. Know your rights with debt collectors too. The costliest outcomes, such as a court judgment, a wage garnishment or a restarted time limit on the debt, usually happen because people didn’t respond, not because of the debt itself.
Key points
■At 30 days late a delinquency reaches the bureaus; at 180 days a card is charged off and often sold, and debt buyers paid an average of 4.0 cents per dollar in the FTC’s 2013 study, which is why settlements…
■A debt management plan at 8% clears $15,000 in 60 months for $304.15 a month, 6.5% of the running household’s take-home pay.
■Debt settlement can cost fewer dollars only if it works; growing balances, fees, lawsuits and tax on forgiven debt eat the margin.
■More than 70% of debt collection lawsuits end in default judgments (Pew, 2020): answering the summons keeps your defenses alive.
A closer look
Falling behind follows a predictable sequence, and almost every option gets worse the further along it you are. The best time to act is before the first payment is missed; the second-best time is before the account is 30 days late.
Call the lender first. Most card issuers and lenders run hardship programs that are rarely advertised: a temporarily lower rate or payment, a skipped payment, or a fixed payoff plan, usually for a few months to a year and often with the card frozen. Ask what will be reported to the bureaus before you agree.
Nonprofit credit counseling is the next step when several debts are involved. A counselor at a reputable nonprofit agency (look for NFCC membership or the agencies the U.S. Trustee Program approves for pre-bankruptcy counseling) reviews your budget, usually free of charge, and may propose a debt management plan (DMP): you make one monthly deposit, the agency pays your unsecured creditors, and the creditors often lower rates or waive fees. The FTC notes that plans typically take 48 months or more; enrolled cards are usually closed. Ask for fees in writing. A DMP is not debt settlement, where a for-profit company asks you to stop paying while it negotiates; that path damages your credit, invites lawsuits, and forgiven debt may be taxable income.
A worked example
Worked Example — $12,000 of Card Debt, Two Rates
Suppose a DMP cuts a $12,000 card balance from 22% to an illustrative 8% (concessions vary by creditor). Paid off over 60 months: payment = $12,000 × (0.08 ÷ 12) ÷ [1 − (1 + 0.08 ÷ 12)^−60] = $243.32; total interest = $243.32 × 60 − $12,000 = $2,599. The same $243.32 a month at 22% takes n = −ln(1 − 0.22 ÷ 12 × $12,000 ÷ $243.32) ÷ ln(1 + 0.22 ÷ 12) ≈ 129.1 months (130 payments, nearly eleven years), and about $19,410 of interest. The rate, not the payment, is doing the work.
Under the hood
Under the Hood: Why Old Debts Sell for Pennies, and What That Means for You
Once a card is charged off at 180 days, the original creditor has written the balance off its books and often sells it. The FTC’s 2013 study of nine of the largest debt buyers, covering more than 5,000 portfolios with nearly 90 million accounts and $143 billion of face value, found buyers paid an average of 4.0 cents per dollar. Price fell with age: the FTC’s model put a typical small card debt under three years old at 7.9 cents, against 3.1 cents at three to six years, 2.2 cents at six to fifteen, and virtually nothing beyond fifteen. Three consequences follow.
What the Research Says: Courts, Defaults and Bankruptcy Outcomes
Most debt lawsuits are won by default. Pew’s 2020 review of state courts found that debt collection suits more than doubled between 1993 and 2013, to about 4 million a year, and that more than 70% end in a default judgment because the defendant never responds. Fewer than 10% of defendants have a lawyer, against nearly all plaintiffs; in Utah, 53% of represented defendants won, against 19% of those without counsel.
What the full article covers
The full article includes worked examples, a look under the hood at the mechanics, a recap, a reveal-on-click quiz and the official sources behind every figure.
Volume V: Personal Finance
Read the full article on FinoLib
The complete article, Debt Collection and Bankruptcy: What to Do When You Can’t Pay, with every worked example, diagram, quiz and source, is free to read in Volume V, Personal Finance on finolib.com.
Explore the Finance Education Series: Vol. II — Capital Markets · Vol. I — Global Economy · Vol. III — Finance Encyclopedia · Vol. IV — Finance Careers · Vol. V — Personal Finance