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How 'Charge Offs' Effect You

Repaying Charged-Off Debts
The Dollar Stretcher
by Gary Foreman

I am curious as to whether or not charge-offs can continue to accrue interest. I was always told "no" but today an attorney for one of those "third party collectors" told me "yes". I had already paid $900 into the charged-off debt and then that collector dropped us after I confronted them about some shady practices - they withdrew funds without my authorization - and a new law firm picked it up and tacked on another $1500 above what I'd already paid!! The first law firm didn't charge interest but this one is. Any information you can offer would be most appreciated!
Jennifer

Sounds like Jennifer is in a tough spot. To make the best of the situation she's going to need to learn a little about what a 'charge-off' really is, how collections work and whether the lender can charge interest on the debt.

When Jennifer borrowed money from a company she created an expectation of future income when the debt was repaid. That's an asset of the corporation.

When a company 'charges-off' a loan, they're saying that they don't believe that they'll ever be able to collect the debt. So they 'write-off' the asset. It's an accounting entry that reduces their profits and taxes.

They'll also report the charge-off to the credit rating agencies. That makes it more difficult for Jennifer to borrow money later. An overdue debt can be shown on your credit report for 7 years after the account became delinquent.

But, that's just the accounting aspects. What happens to the debt in the 'real' world?

Just because a debt has been charged-off does not mean that Jennifer still doesn't owe the money (plus interest and penalties). What she owes depends on the original loan agreement, state law concerning the Statute of Limitations (SoL) and the federal law governing collections.

The original terms from the loan still apply. All that fine print that no one reads becomes important now. Generally it gives the lender quite a bit of latitude to charge interest and penalties.

Next Jennifer needs to find out the statute of limitations (SoL) on her debt. In most cases it's between 3 and 6 years. State law and the type of debt will determine the SoL. The SoL says that after a certain period of time that the debtor is no longer legally required to pay a debt.

There are actions that Jennifer could take that would restart the clock on the SoL. Making a payment, signing an agreement to pay or even admitting that the debt is valid could be enough to stop or reset the SoL clock to zero.

She'll need to do a little research to learn the SoL in her state. Her phone book should have a number for the state's information operator. They should be able to point her to the state agency that can explain the law.

Two notes about SoL. Even though the SoL says that a debt doesn't have to be repaid it's not illegal to attempt to collect it. And, if the lender gets a judgement against the borrower there's no SoL on the judgement.

Jennifer also needs to know a little bit about collection agencies. Some work for a percentage of any money that they're able to collect. Others buy a group of bad loans for pennies on the dollar. Then they keep everything collected. Since they own the loan, they're also allowed to re-sell it to another collection agency. That could explain why Jennifer has heard from more than one agency. They're also sometimes affiliated with law firms so that they sound more important.

Whoever owns the loan, original lender or collection agency, is allowed to keep charging interest and penalties per the original loan agreement and applicable laws.

Anyone trying to collect the loan is supposed to obey the federal Fair Debt Collection Practices Act. But, as you'd expect, some will bend or even break the collection rules.

It's no surprise that they tapped into Jennifer's bank account. She might have given permission without realizing it. They will also try to garnish her wages or put a lien against any property that she owns. There are, however, laws that keep them from just taking anything they find.

If Jennifer does agree to settle the debt by paying a portion of it, she needs to get a release from the agency saying that the balance of the debt is forgiven. She should look for the words "payment in full".

Once a debt as been reported as written-off, paying it will not wipe away the bad comment in her credit report. It will look better, but only slightly. It's possible that the original lender may agree to remove the item if a partial payment is made. But, only the original lender may do that. Not an outside collection agency.

Hopefully Jennifer will be able to close this unfortunate episode and never have to revisit the issue again.

Gary Foreman is a former financial planner who currently edits The Dollar Stretcher newsletters and website www.TheDollarStretcher.com You'll find hundreds of articles to help stretch your day and your dollar!

Piggyback Mortgages and PMI

The Dollar Stretcher
by Gary Foreman

Dear Dollar Stretcher, We have a new home under construction. After paying off debts we don't have enough for the 20% down payment to avoid PMI. I am trying to compare a low fixed rate 30 year mortgage to an 80/15/5 mortgage where the PMI is waived.

Is an 80/15/5 mortgage a good deal for the borrower or just for the lender? Most of the info I found was from brokers. It is hard to be too confident about their information since they are selling the product.

Rob in Texas

Like many people, Rob is anxious to enter the housing market. Low interest rates make mortgages more affordable. But they also drive up housing prices. Which means more people are having trouble saving an adequate down payment.

Let's begin with a couple of concepts. Private mortgage insurance (PMI) helps people to buy homes when they have a small down payment. PMI does not protect the homeowner even though they pay for the insurance. It covers the mortgage company if the borrower stops paying.

PMI may require an initial payment and/or a regular monthly payment. A smaller down payment means a higher PMI premium. Typically, the homeowner is allowed to cancel PMI after they have equity in their home of 20%. They can build equity by paying down principal or by seeing the value of the home appreciate through rising prices. As you would expect, everyone wants to stop paying for PMI as soon as they can.

Which brings us to the "piggyback" or combination mortgage. How does it work? The first mortgage company provides a mortgage for 80% of the property. A second mortgage company that doesn't require PMI grants another mortgage for 15%. That leaves the buyer to come up with the final 5% as a down payment. It's like getting a 95% mortgage without PMI. Thus the 80/15/5 description.

There are some variations on the piggyback. Some are 80/10/10. Others even ask the seller to come up with the final 10% so that the buyer needs no money down.

Why would Rob use a piggyback? Mortgage payments are tax deductible. PMI payments are not. If you pay off your 2nd mortgage early, you can reduce your monthly payment. Sometimes the seller is willing to carry the second mortgage at rates lower than traditional lenders.

But, Rob is right. There are some disadvantages that often get overlooked. Second mortgage rates are typically higher than those charged on first mortgages. It's possible that the combined mortgage payments could be higher than a single mortgage plus PMI payment.

The second mortgage will have a second set of costs associated with it. Some even carry a prepayment penalty.

And, second mortgage payments will continue until that loan is paid off. PMI can be cancelled when your equity reaches 20%.

Rob also should beware of 'balloon payments' on the second mortgage. He may be offered a loan that's amortized over 30 years. In other words, the payments are calculated as if you'll be making them for 30 years. That makes for low monthly payments. But at some point in the future (usually 10, 15 or 20 years) the balance of the loan is due. That balance is the 'balloon'. And the homeowner is required to come up with the cash or refinance at that point.

So which is best? In part it will depend on the rates that Rob will be offered on first, second and PMI. He'll also need to consider how long it will be before he has a 20% equity in the home and can cancel PMI. Rob can take that info and estimate what his payments will be in future years. Unfortunately predicting the future isn't an exact science. So there is no one correct answer.

Finally, a warning to Rob and others with small down payments. Housing prices can decline. One industry study estimates that there's roughly a 6% chance that housing prices could drop 10% in the next two years.

When interest rates rise people will not able to afford as much housing. For instance, if rates rise from 6% to 7%, a buyer can only spend 90% of what he could at the lower rate. So the check that paid for a $200,000 mortgage now becomes the payment for a $180,000 loan. That could hold down home prices.

Many people are familiar with the concept of being 'upside down' in a car loan. That's where they owe more money than the car is worth making it difficult to sell or trade the car.

Being upside down in a mortgage could be significantly more painful. Imagine that you've lost your job and need to move to a new city to regain employment. But the only way that you can sell your home is to bring a check for $10,000 to the closing because you owe more than it's worth. For many that would be an impossibility. So please move cautiously if you're buying with a minimal down payment.

Gary Foreman is a former financial planner who currently edits The Dollar Stretcher website www.stretcher.com and ezines Copyright 2003 Dollar Stretcher, Inc. all rights reserved.