After loan default, how bad can it get?
Debt collectors can boost amount owed, but courts setting limits
After you default on a loan, collectors often try to puff up the debt, heaping interest and fees atop the balance you already owe. How bad can it get?
Plenty bad -- one collector tried to charge Montana resident Tim McCollough $5,500 in interest on top of his unpaid $3,800 balance on a Chase card.
Consumer advocates say you should turn a skeptical eye on these claims. It might be legal for a debt buyer to charge interest on money it never loaned to you, but the amounts they can tack on are limited and courts are increasingly forcing them to justify their claims. McCollough, a retired school custodian, wound up winning a six-figure judgment against collection law firm Johnson, Rodenburg & Lauinger LLC for abusive practices. The decision was affirmed in 2011.
"If a debt buyer purchases (your debt), the right to collect interest is not automatic," said Peter Barry, a consumer lawyer in Minneapolis.
Interest claims are part of a larger controversy surrounding sold-off debts, which include about $50 billion in unpaid credit card debts sold each year. In a landmark report in January, the Federal Trade Commission concluded that debts are frequently sold with just scanty information about their origins. The lack of information makes it hard to tell if the amounts are correct, or even whether the right person is being targeted. But since debtors fail to show up in court for most of these cases, weak claims -- including interest charges that are made up out of thin air -- can slip through the system.
The claims can be inflated or downright baseless, as Catherine Petrilli of Lansing, Mich., discovered. Chase Bank wrote off her account after she defaulted and stopped charging interest in 2008, leaving an unpaid balance of $1,058. Two years later, debt buyer Asset Acceptance claimed she owed that balance plus an extra $400 -- an increase of nearly 40 percent -- based on retroactive interest charges. But there was a big problem with their math: Asset Acceptance started charging Petrilli interest two years before it owned her debt.
"It's certainly interesting when somebody is putting in an affidavit claiming an amount is owed, but they made up the amount," said Daniel Edelman, a consumer lawyer in Chicago who represented Petrilli.
In a stern ruling in August, a federal court in Michigan found that Asset Acceptance violated collection law by making "false statements regarding the total amount of the debt." The company is seeking permission to appeal the class-action suit, but consumer advocates say the ruling struck a blow at claims for interest.
Charge-offs change debt's legal status
After you default, there are important changes in the legal status of your debt. Rules that protect banks' soundness require them to write off, or charge off the amount after it has been delinquent for six months. The charge-off removes your unpaid balance from the bank's assets and puts it into the "losses" column.
Almost all card issuers stop charging interest when they charge off a debt. That's because continuing to charge interest would mean having to send monthly statements to cardholders, under the U.S. Truth in Lending Act. Besides, the uncollected interest inflates the lender's losses.
If a debt buyer purchases (your debt), the right to collect interest is not automatic.
|-- Peter Barry
"They don't want to put it on their books, when there's only a slim chance they'll recover it," said Ronald Canter, a Maryland lawyer who represents banks and debt collectors.
Writing off the debt does not mean it goes away. To the contrary -- the lender may hire collectors to hound you or it may sell the debt on the debt market. Once the debt is sold, its legal status changes yet again. Debt buyers, not subject to Truth in Lending, claim the right to charge interest on the unpaid amount without sending you monthly statements. That is the basis for demands that include years of built-up interest that the bank never charged.
"Debt buyers purchase these debts with all the rights, title and interest of the assignor to the indebtedness and therefore have the same rights as the assignor to pursue the debt," the debt buyers industry group DBA International stated in a paper filed with federal regulators.
Principal and interest
Claims from collectors often refer to the charge-off amount as the "principal amount," to distinguish it from interest added later by the buyer of the debt. Consumer advocates say that the term is confusing, because the so-called "principal" includes interest that was charged by the original lender. Debts in collection are usually loaded with such interest. For example, a $1,500 delinquent credit card balance would grow to $1,845 by the time it is charged off, at 26 percent interest and late fees of $25 per month.
"From the moment you default, every month they're charging fees, they're going to continue adding on interest," said Peter Holland, a University of Maryland law professor who runs the school's legal aid clinic.
In 2005, the 7th U.S. Circuit Court of Appeals affirmed a debt buyer's right to continue charging interest rates north of 18 percent to Illinois residents Enrique Olvera and Jeffrey Dawson, based on rates charged by their original lender. The ruling is often cited as a pillar of the longstanding principle that the owner of a debt "stands in the shoes" of the original creditor.
More recent cases, such as Petrilli's successful defense, show that such claims are far from a slam-dunk, however. Some states are skeptical of debt buyers' ability to charge interest rates above the state statutory limit, a right reserved for national banks. Then there is the question of the correct interest rate. A debt buyer may charge the periodic rate indicated on the last account statement -- but is this rate justified by the card agreement?
The U.S. Fair Debt Collection Practices Act says collectors can add fees or interest only if the amount is "expressly authorized by the agreement creating the debt or permitted by law." That requires having a copy of the original card agreement to prove the interest is permitted, consumer advocates argue.
In Maryland, debt buyers "would just continue to charge that interest (but) they didn't have a copy of the actual agreement," said Holland, author of a paper entitled, "Defending Junk Debt-Buyer Lawsuits." "If they continue to charge interest (based on the card agreement), you're going to want to see that contract."
Christine Green, staff attorney at the Georgia Legal Services Program, said that the variable rates charged on most credit cards make it harder for debt buyers to claim they are charging rates permitted by contract. For variable rate cards, the interest rate is stated as a formula linked to the prime rate. The actual rate that you qualify for may be left out of the agreement entirely, and sent to you individually by mail. "All they (debt buyers) have are computer printouts; they don't have the mailings that were sent to the debtor," Green said.
She often sees debt buyers backing away from claims for post charge-off interest. Having bought the debt for a small fraction of the charge-off amount, they focus on collecting that. Interest on top of the charge-off amount "is going to be tough to prove," Green said. "They don't want to mess with that."
State laws comes into play
Debt buyers may claim interest other than through their rights under a card agreement. Many states specify the interest rates that creditors, including debt buyers, can charge on a debt that lacks a rate set by contract. A simple IOU that carries no interest may be subject to the interest rate under state law for a debt of a known amount. Georgia, for example, allows "pre-judgment interest" of 7 percent.
If they continue to charge interest (based on the card agreement), you're going to want to see that contract.
|-- Peter Holland
University of Maryland
Consumer lawyers say they see debt buyers more often pursuing these usually lower rates, but that these claims are open to challenge as well. Green said that the debt buyer should be able to show that the contract amount -- which trumps other rates -- was not less than the statutory limit. In one case, a debt buyer claimed the statutory 7 percent interest rate, but the original credit agreement carried a rate of 5.9 percent, she said.
In Maryland, the state constitution sets a rate of 6 percent for pre-judgment interest, Holland said. New court rules in Maryland allow debt buyers to claim the statutory rate without filing the original credit card contract. "If you're seeking the state limit for pre-judgment interest and you're not asking for attorney fees, that was the compromise," Holland said.
Attorney fees are another source of inflation for old debts, but these are added by courts when one side has won. Most card agreements allow "reasonable" attorney fees, giving judges wide latitude and making it difficult to predict the resulting costs beforehand.
As the controversy around debt collection continues, several states have written new laws or court rules designed to protect consumers from unfair default judgments in debt collection cases. Maryland, California and Minnesota have passed laws requiring debt buyers to have documentation for claims, and other states are looking at similar measures.
In Texas, a merger of small claims courts led to combined rules effective August 31. For claims under $10,000, creditors can charge interest up to an 18 percent usury limit without submitting original contract documents. Bronson Tucker, general counsel of the Texas Justice Court Training Center at Texas State University, said that the rules require the debt buyer to submit sworn statements about the validity of the claims, putting company officers in hot water if the claim turns out to be invalid.The federal government is also working on an update of collection law, via new regulations from the U.S. Consumer Financial Protection Bureau. It's not known what shape the rules will take, but it's widely expected that debt buyers will have to do a better job of documenting claims.
What to do
How should you deal with demands for post charge-off interest? Whether you are negotiating with a collector or mulling your response to a lawsuit, it is important to remember that a debt buyer's claims for interest could be inflated -- or downright baseless, consumer advocates say.
Claims for interest bolted onto an old balance can make the original debt unrecognizable. You might ignore demands for an amount you don't recognize, coming from a company you never did business with. But the worst reaction to these claims is to ignore them, consumer advocates say. Once a default judgment is entered against you, it can be used to seize your assets or garnish your wages many years later.
How should you deal with claims for post charge-off interest?
Step one is to determine the amount of your debt at charge off. This may be called the "principal amount" by a debt collector. This should be the balance showing on the last statement from the lender. The same amount should also be shown on your credit report as the balance due for the delinquent account.
If the debt buyer is claiming an amount greater than the charge-off amount, determine how much more, and look at the basis for the claim. If the interest charges start from the date of the charge-off, instead of the date that the debt buyer bought the debt, you may, like Petrilli, have a case against the debt buyer for unfair debt collection.
If you are negotiating with a collector to settle the debt, experts say to start with the charge-off amount as the basis for discussions. Claims for greater amounts will have to be proved in court by the debt buyer if they don't settle with you. If the collector does not have a copy of your credit card agreement, plus the sale contract showing that the right to collect the debt, with interest, claims for post charge-off interest will face tough sledding in court.
If you have already been sued and post charge-off interest is part of the claim, the stakes are higher. Many lawsuits are high-volume, low-documentation claims that do not hold up when challenged. However, some debt buyers can obtain account documents to support their claims, while some courts, as in Texas, will accept sworn statements in lieu of original documents. You can search for consumer lawyers in your area using the website of the National Association of Consumer Attorneys. Some firms offer sliding fees and, if they find errors by the collector, will be able to get the other side to pay the fees.
"There are times when people represent themselves successfully, said Kris Skaar, a consumer lawyer in Georgia, "but the vast majority of the time people come out better economically (with representation), even if they have to pay the attorney something."See related: 7 steps to take if chased by zombie debt, Interactive: Life cycle of a delinquent credit card account
Published: October 16, 2013
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