What Clients Need to Know About Debt Reduction

“Do you owe money to credit card companies?” You’ve likely seen the advertisements on TV promising to reduce what you owe to the credit card company. Some of these ads even suggest there’s a new government program to bail people out. However, there isn’t. If a client with debt asks for your advice, what should you do?

Let’s take a moment to consider the real problem. Many people spend money they don’t have without any idea of how they will repay it in the future. Credit card statements say how many years it would take to pay off the balance by making minimum payments and suggest paying it off in fewer years with larger payments, but many clients need to learn about budgeting. Often, however, they choose to keep spending. Here are some debt-reduction questions and tips to consider:

Beware of scams. Your client likely wouldn’t lend money to a dodgy family member,  borrow money from a loan shark or fall for an internet scam requesting money. However, they might be tempted by an ad for debt relief that sounds too good to be true if they are in serious debt. Why? Because the language in these ads is incredibly persuasive. In fact, the Federal Trade Commission has been going after these operations for years. A clue that the offer is a scam is that it promises to get creditors off your client’s back yet requires a large upfront fee or a series of regular payments.

How do the legitimate programs work? There is no hidden federal program for bailing your client out, and it’s not possible to make debts owed to the IRS or student loan debt disappear. Yet, there are businesses that seek to renegotiate a person’s debt with their creditors. These businesses will review your client’s situation and suggest your client stop paying her creditors. The immediate consequences are penalty fees, interest and damage to your client’s credit score. These businesses take the money your client would otherwise be putting toward monthly credit card payments and put it into a dedicated savings account. The business then contacts the creditors, points to your client’s pool of saved money and attempts to negotiate a settlement for less than the amount your client owes. The logic behind accepting this deal is that half a loaf is better than none. The process takes at least two years, however, and requires discipline. 

Can you cut out the middleman? Logically, your client should be able to negotiate directly with her creditors. The firm your client owes may have a program to help them if they have difficulty paying.

Home equity line of credit. Let’s say your client isn’t over their head in debt, but they are carrying revolving charge card balances. Your client may also have a home equity line of credit (HELOC) that isn’t tapped out. Compare the rate of interest on their credit cards to their HELOC rate. It might be 16 percent versus 4 percent. In both cases, rates are variable, which is a risk in an environment with rising interest rates. Why is the HELOC rate so low? It’s a secured loan, which carries its own set of risks. Your client might use the HELOC to pay off the credit cards, cut up all except one card and make the same aggregated (or larger) monthly payment to their HELOC to pay down the outstanding balance. Unlike credit card interest, HELOC interest is generally tax deductible, subject to limitations. 

Consolidating credit card debt. Let’s say your client does not have a HELOC or rents their home. The credit card companies realize that people who use charge cards tend to keep on charging, so they will often offer the opportunity to transfer the outstanding balance from one card to another, often at a low introductory interest rate. Some cards charge less than others, depending on the issuing institution. It makes sense for your client to take advantage of these lower rates while making a strong commitment to reducing the overall balance. However, the losing institution may have a fee they assess. Also, those introductory rate periods end, at which point your client will be paying the full interest rate. 

Declaring personal bankruptcy. This is the nuclear option for when your client is in way over their head and cannot see a way to emerge from their accumulated debts. It can stop the foreclosure process and eliminate some debt, but it will destroy your client’s credit score, the effects of which last for seven to 10 years. It can affect your client’s future employment if the firm doing the background check considers your client a risk.

Your client likely hasn’t considered all of these options. However, the first option, which might be a scam, could get their attention. As their accountant, you are in a position to help your client see the big picture. When it comes to debt, the tunnel is often very long, but there is a light at the end.