Charged Up! podcast: The truth about debt
Episode 52 with debt settlement expert Brad W. Smith
Former Wall Street investor turned debt settlement professional Brad W. Smith has seen clients swimming in money and clients drowning in debt. In his book "Let's Talk about Debt," he reveals the kind of consumption mindset that can easily get even typically financially healthy individuals into a debt spiral and what they can do about it. He has settled hundreds of millions of dollars of debt for thousands of clients. In this podcast episode, Smith gives us his tips for avoiding debt and getting out of it if we're heading in the wrong direction.
So, let's get Charged Up! to talk about debt.
Hoff: Thank you so much for joining me today.
Smith: Thank you for having me.
Hoff: So first let's talk about your background. You worked on Wall Street during the boom times and then started your own firm and saw the financial mistakes people were making. You mentioned in your book how people were treating their homes as ATMs. Can you tell us a bit about your background, and how you eventually ended up advising people on avoiding and getting out of debt?
Smith: Yeah, absolutely. I have an interesting perspective on it in the sense that I did work on Wall Street for a number of years, dealing with the ultra-high net worth individuals. And I also spent a good portion of time owning my own mortgage banking firm. And really after spending a few years doing that, during the mortgage heyday if you will, we looked at about 20,000 to 25,000 credit reports over that time, and it really gave us a very good insight into what people were doing with their finances.
And I can tell you, we used to see people refinancing every nine to 12 months and just really counting on the appreciation of their home to be able to access that equity to really pay down credit card debt. It wasn't uncommon at that time to see people with $50,000 to $80,000 of credit card debt. I mean, it got to a point where it was almost a standard or a very common place.
Hoff: Wow. And what other things did you see? What made you want to get into helping people get out of debt?
Smith: I think it really came down to looking at a person's debt income ratio or what their minimum monthly spend was. And it just was something that we looked at as an ownership proof, and we just realized this was absolutely something that couldn't continue, it was unsustainable. It was something that long term these individuals were going to have an event of some type that was really going to put them in a very bad place.
Hoff: And so that made you totally decide to switch gears?
Smith: It did actually. We looked at this and thought, "OK, well, if at some point in time real estate values start to come down or even stabilize, and they're not going up by 15 to 25 percent a year depending on where you live," we knew at some point in time that that house of cards really is going to come down.
So really, my partners and I, looked at that and said, "OK, how does the great deleveraging or unwinding of all this, how does this really occur?"
Hoff: Wow, and so you were right there at the front lines to witness when it did occur. And when the housing market just totally crashed and people lost their homes and were in debt and just had to almost leave their homes in a lot of cases, and just walk away. What did you learn from that experience? When you saw all of this crashing down, what did you learn when it came to debt and how to advise people to avoid this kind of situation in the future?
Smith: It's interesting you asked, as part of my previous career as a financial adviser for larger Fortune 500 entities, it was always something that the people that ended up in the worst position was entirely because of leverage.
And it was either taking out large loans against volatile positions. Or, in the case of housing, it was people who took out loans that were 99 percent of the value of the home, or, in some cases, there were lenders out there that were loaning more than a hundred percent of the value of a home, it wasn't uncommon for you to get maybe a 105 or 125 percent cash out on your home.
And it was the degree of leverage that we really looked at and said, "These aren't sophisticated people. I mean many of them this is the first time that they've owned a home." They just figured, "Well, this is what everyone else is doing, and this is going to continue for some time." So it's really the degree of leverage that we saw that was a concern for us and made us want to get into the debt management space.
Hoff: And I want to go more into what you've seen and your advice for people who do find themselves in debt. But just in a general kind of societal behavior, have you seen it really changed the mindset of people the way they were before when it came to borrowing against their houses and putting tons of money on their credit cards to help people kind of behave in general now? Have you seen a shift?
Smith: We definitely saw a shift right around the 2008 time frame. We saw a good three to four years of unwinding or deleveraging of the American consumer. Most of that was not by choice, it was lenders or mortgage lenders, people who were giving that easy credit or easy money no longer were doing so. So it really forced individuals to really deleverage themselves and really start to pay this down.
What we track, we track really some of the macro levels that look at how much credit card debt, how much housing debt people have overall within the United States. And now we tell you that as of today we are back to those 2008 levels. So I hate to say we didn't learn much, but the American consumers, and again some of the lenders out there as well, I kind of put some of the blame on them, their memory is very short term in nature.
Hoff: Wow, so you are seeing people make the exact same mistakes as they were making before 2008?
Smith: Yeah, we're seeing the same amount of average indebtedness, if you will, as far as unsecured credit card debt. We're seeing mortgage loans that really are government backed, where consumers are putting down 3 percent or in some cases 1 percent of the down payment.
Historically, if you go back 25 or 30 percent it's always been that a customer, homeowner, new homeowner needs put down 20 percent in order to qualify for a home loan, which has given them quite a bit of skin in the game. Well, and they're only putting down 1 to 2 percent and it's a government-backed loan, and we find that we're getting close to being back in a very similar predicament.
Hoff: Wow, and I definitely want to talk about obviously credit card debt and the different types of debt that people can have, and I thought you had some really interesting numbers in your book, "Let's Talk About Debt," when it comes to what you're paying an interest in a credit card versus what you pay an interest on a different type of loan. So I want to get into all of this. But first, you start your book with this treadmill example, how one punishment for debt was once putting them on a treadmill that powered nothing, so essentially working for no reason. Why did you start your book with this, and how do you think it relates to debtors' experiences today?
Smith: Well, I think it's very similar. There was the Credit Card Act of 2009 that mandated that each credit card company start to, in the upper right-hand corner of a statement, show how much debt you had, and if you made the minimum monthly payment how long will it take you to pay it off and what would be your total payback terms. This was huge.
Prior to 2009 I don't think consumers really had a very good idea of what the cost of credit was to them. I think they were trying to maintain a good credit score by making these minimum monthly payments, but when it came to looking at how long it was going to take them to get out of debt there were no question that they were on a treadmill. If they make that minimum monthly payment it's a 30-year rate payoff. And the repayment for borrowing $10,000 was $32,000.
I don't know that the American consumer up until that change occurred had it thrown in their faces what the real cost of this credit is and how long it is going to take to pay it back
Hoff: Yeah, and it's interesting, I work obviously with CreditCards.com, so we have a lot of knowledge about credit cards, but even to me when I get my credit card statement and I pay my credit cards off in full every month, but when you get that statement and you see ... if you pay the minimum for this many years, I mean, it's astronomical the difference in what you're actually paying. And suddenly that $10 dish towel becomes a $100 dish towel if you pay just the minimum.
You definitely caution about how credit card companies charge interest, and the wrong ideas that many people have when they carry a balance, which we just briefly talked about, but let's talk more about that, what do we need to know when we're using credit cards and more important when we're carrying a balance on them, how is it different from other types of debt?
Smith: I think it really comes down mostly to how the interest is calculated. Most credit cards, not all, but most will compound that interest on a daily basis. Some of the newer marketplace lenders were online lenders that are offering loans to consolidate credit card debt. If we compare apples to apples and they both had the same rate, some of the marketplace lenders are really charging that interest in a simple interest format, meaning that the monthly payment is the same each month. It's not compounding daily.
So that really an APR of say 21 percent on a credit card would really equate to somewhere in that 16 percent rate on a similar type of product that isn't compounded daily. So really you have to understand exactly what type of loan that you're being offered and how that interest is being compounded is very important.
Hoff: So let's talk about the difference, let's say maybe you will compare a mortgage that you pay to a credit bill. So a mortgage is this fixed interest, you pay the same amount every month; you know exactly what you're paying down. Whereas with a credit card like you're saying it's compounding every day, so as an example let's take $10,000, you have $10,000 on your credit card and if you make the minimum payments, how much are you paying debt at the end of the day in general?
Smith: It's hard to say exactly, because again the interest that you're paying today on the 10,000 you're paying whatever occurred on the next day on that. So it's really it's compounding on a daily basis, whereas a mortgage loan is occurred over a much longer period of time. So it's hard to say exactly.
Smith: But I can tell you when if you look at the two it's substantially different.
Hoff: So you're paying interest on your interest with a credit card?
Smith: No question, yeah.
Hoff: So as your interest accumulates that increases your balance and you're paying interest on that interest. It's something to think about. So you're not just paying interest on what you bought you're paying interest on the interest that you've been charged, and it keeps going on and on and on.
Hoff: So I found a part in the book about clients calling sometimes without power in their house or crying because of collectors calling them. What is the breaking point for somebody to call and say, "Listen, I need help to get out of this debt and get my life back?" What would you say are the most common reasons somebody has gotten themselves into a type of debt they just can't handle?
Smith: It usually is some type of life event where it's the lost of a job, or in many cases we find that married couples are hiding debt from one another and that their spouse has found these credit cards or has run their credit in some way and found that there's a substantial amount of debt that they were unaware of. In many cases it could be the power being shut off, it could be the lost of a job is one for us that seems to be pretty common place.
There are just so many reasons. I mean, we've gone back and done a lot of historic research to look at who our target client is and are they single parents, are they Republican, Democrat, are they ... Who are they? And then unfortunately in every case it's about 51 to 49 percent, it seemed to be everyone across the board.
I mean, even when we break it down to difference states, different regions of different states, it really seems to be there are a lot of people that really fall back into that same category.
Hoff: Wow, and it's usually a big life event, so not necessarily something that they could have controlled but something that just kind of got out of control, whether it's a divorce or hiding money from your spouse or a medical issue. What is usually the point where somebody needs to come and get someone to help them get out of that debt?
Smith: I think it's at that point when they realized that they're not going to be able to make these minimum monthly payments. And whether it's a decrease in income or a divorce, they just know that at some point in time they actually need to do something. And that's the point in which they usually reach out to us.
I don't think ... interestingly enough I don't know that a lot of people know that in case debt settlement or debt management, it's not very sexy or really advertised all that much. So in many cases I don't know that they really know about what their options are.
Hoff: So what are their options? Talk about what that process looks if you go do a debt settlement or you work with somebody who's going to consolidate the debt for you, what are their options, how does it work? Because I'm assuming that some people think, "Well, it's just a company, they're going to make money off me too, it's just going to put me more in debt." So how does it actually work?
Smith: Sure. So on the debt settlement side, typically when people come to us they're very highly leveraged. In most cases they've started to miss some monthly payments here and there. And what we do is we go in and we negotiate settlements with each one of their creditors. Typically that's 50 cents from the dollar, and we put them back on a three- to four-year repayment plan based upon what they can afford.
Before getting into this industry I spent 10 years as a financial adviser, I had never heard of it. I had heard of consumer credit counseling. Obviously there are several different types of bankruptcies, I'd heard about home equity loans and consolidating credit card debt that way, but really the debt settlement plan is really an alternative to bankruptcy.
So this is for people that don't really have a whole lot of other choices, they've never accessed a credit at this point in a way of a new loan or a home equity loan or anything of that nature. Their credit has been tarnished enough to where they most likely wouldn't qualify for that.
Hoff: OK, so they're going to come to a debt settlement, so if this is kind of their last resort before bankruptcy, it does do damage to their credit, correct?
Smith: It does. Roughly, it's 30 percent of someone's overall credit scores derived from their payment history. And typically when they enter into a debt resolution program they're not making those payments to the creditors any longer, they're actually making them to a dedicated account and we're utilizing that money to go in and settle with each one of their creditors.
So again, it's not for everyone. It doesn't come without some pain in the way of near term credit impacts, slight payments, charge off, things of that nature, as well as believe it or not the stress and anxiety of receiving collection calls. Our technology now is such that automated dialers, it's very easy for them call your office, call your home and call your cell with an automated dialer for every hour for whatever is legal in that state. So it definitely does come with some negative consequences.
We typically operate on a performance based program, meaning that if we don't get you results we don't get paid. Some laws were changed in 2010 that somewhat mandate that, and I would say that any firm that you would talk that doesn't abide by that or is charging you some type of upfront fee or retainer fee or anything of that nature, I would stay very far from it.
Hoff: And let's talk also about the tax issues, because I know we've written stories on this, and people may not realize that when you do debt settlement you still have to pay taxes on kind of the money that was fore given, correct?
Smith: You do, because the credit card companies are written that off, and they in many cases will send ... not in all cases, but many cases will send you a 1099 based upon that money that you received. Depending on people's hardships and what is really going on behind the scenes, there are some tax strategies that they can employ. There are certain forms that they file with their tax returns that would limit them from having to pay taxes on that money if they're truly in a position where they're upside down.
If it's a consumer that's really just trying to manipulate or play the game, I would tell you that in many cases they are going to receive a 1099 and they're going to have to pay taxes on that money that was fore given.
Hoff: Right, and with that means it's almost as if they were being paid that money, correct? So that's the kind of taxes they would pay. So if you had a hundred thousand dollars in debt, you get 50,000 with fore given, you have to pay taxes on that 50,000 as if you earned it, correct?
Smith: That's correct. It comes over in the form of a 1099 the same way you would if you were an independent contractor or if you would made the money via some sort of investment, absolutely.
Hoff: So it's something to think about when people do consider this, and they think, "OK, I can afford this 50 percent." It's not just that amount that you're paying. You have to pay more on top of that. But as you said there are some taxes strategies depending on how desperate your situation is and what kind of money you have available to you, right, that you might be able to fore give those taxes and not have to pay those.
Hoff: OK, when it comes to creditors you said there's automated calling, people are getting called at their work, they're getting called at their home at all hours. What are our rights? What are things that we should know?
Smith: It's interesting. It's one of the main reasons that people will fall out of a program like ours or maybe not at all in the first place, because it's very serious. And the debt collection industry I would say over the last five years has definitely gotten better, but we definitely still hear stories about people telling consumers that the sheriff's coming to the house and that they're going to be arrested. I mean, we've heard just terrible things.
I would say that the first thing I would do whenever it comes to dealing with a creditor is make sure that you know who you're talking to and that you can get all their contact information and you can make sure that that entity can be located easily.
In many cases we've found that some creditors maybe using fake names or different identities in order to obtain debt or to scare consumers, that way if it comes back to haunt them they are unable to be found in some way. But I'd say in most cases it's really important to know exactly who it is you're speaking with, and know that the company is a reputable company.
There are numerous times that these debts are sold from collection agency to a collection agency that the debts are not accurate or they have not been updated in some way. So it's really important. I mean, I myself have gotten and received phone calls, I have a very common name, and I've gotten phone calls from people that do owe money back, and these people have made threats to me and I said very polite just prove ... if she can prove what it is that I took out and send it to me I'd love to pay it. And then you never heard from them.
Hoff: So what about them calling you to work? Is that something that's allowed?
Smith: Technically it is allowed. I would say that you can notify them especially if you're at a position where if you take numerous phone calls at work that you can be terminated. They can be notified in writing or verbally that you're not allowed to be contacted at work, and you can provide them your cellphone number or home phone number.
In many cases too if you saw a credit card application there is an area for references. And those references can sometimes be called as well, so if you put your in-laws on there or friends, they may try to contact those individuals as well to get that repaid. But for most cases if our customers should get a call at work we do ask them very politely, just let them know they're not allowed to receive phone calls at work, it could put their job in jeopardy. And definitely just provide them a different phone number in which to contact them.
Hoff: And when you're going through debt settlement, does that increase the number of calls you get from creditors or how does that work? And when you're done having settled the debt, does that mean the calls stop?
Smith: So typically once the debt has been settled or an arrangement has been set up the calls will stop. But I would in most cases because until that agreement has been made that settlement can have those phone calls increase because that entity is continuing to call for money that is owed to them, so absolutely. In many cases entering into a debt settlement program would increase those phone calls.
Hoff: OK, wow. Let's talk about bankruptcy, what are the different types of bankruptcy? And when should someone consider it and what impact will it have on their life afterward?
Smith: Sure. So typically what we see with consumers are really there's two types. The first type is a Chapter 7. And a Chapter 7 is what we call a full do over, it's basically giving that consumer the ability to release all of the unsecured consumer debt and really just wipe it clean with a clean slate. You do have to qualify for it, not everyone will qualify. It is income based, so if you make too much money that's very unlikely you would qualify for it.
The long term impact really comes down to public records and the social stigma really of filing for something like that. It will stay on your credit report or it will be part of public record for seven years. So anyone that does background check on you if you have a security clearance, or in any case you have financial securities licenses or you're a banker or anything in that nature, it will have a very serious impact to those licenses.
So we find that many people that really perhaps could be a candidate for bankruptcy but have a security clearance or they're in the military or they're somewhere to where bankruptcy is not an option, they find that debt settlement is a better option.
Hoff: All right, yeah.
Smith: The other type is a Chapter 13. And the Chapter 13 is really more of a restructuring of the debt. A trustee comes in and takes a look at all of your debt, takes a look at your budget and then basically makes an arrangement between you and your creditors that says, "You can afford this, and they deserve to be paid back this amount."
And something to where that trustee really mandates what you can afford. And you're really paying back 100 percent of what you owe. And it's typically just on a reduced interest rate.
Hoff: And so does that impact your credit less? Or why would somebody choose to do that?
Smith: Yeah, it really ... most of the people that will start down the path of a Chapter 17 for some reason that will not qualify because they make too much money are people that will end up in a 13. There are only certain instances in which we feel that that makes a whole lot of sense, because the long term implication to your credit is really about the same.
Smith: We also find that the success rate on a Chapter 13 isn't always as good as we had hoped, meaning that that ... Well, I should put it two ways – trying to be maybe a little bit more aggressive or the consumer may have spending habits that don't allow them to complete that. So the success ratio of those we've had to be a little bit lower.
Hoff: And when we aren't taking out a loan, what should we know? What should we look for? How much time do we have to compare rates for example without continually dinging our credit score?
Smith: Just as the credit bureaus do for mortgage inquiries and auto inquiries, if you apply for ... and on security consumer loan, I believe it's a seven-day window in which they will allow you to do any other inquiries that you'd like. So you really got seven days in which to make a decision on which type of loan that you are looking at, without it impacting your credit.
I would tell you that most cases today if you're dealing with a reputable company, someone that's been in the lending space for quite some time, most of those lenders will offer you loan terms on what we call a soft inquiry and rather than a hard inquiry. A soft inquiry has no impact to your credit score, so you can really shop these lenders a little bit more to custom tailor your loan amount and your pay back terms more before you really execute that hard inquiry.
Most lenders today are doing that hard inquiry on the backend of the funding of the loan once you accept the terms of it, then they would do the hard inquiry and make sure that everything on your credit is as it should be. Other than that it comes down to really the cost of credit and what that APR is.
The APR really is a way of looking at what the interest rate is, and what the total cost of that credit is including any fees. So if there is a larger origination fee on the frontend, or there's a pre-payment penalty which is only allowed in a number of states you can separate or compare apples to apples really by just looking at the APR.
Hoff: Yeah. OK. That's good to know. And then I was going to ask people come to you when they're kind of in a desperate situation now, like they have to get this thing settled, the power's off or whatever the situation. What are three tips you have for people who are facing debt right now to avoid that situation?
Smith: Well, to avoid it the first thing I have them do is really take a look at their credit card statements today. They need to know what the absolute cost of credit it and really what they're doing. So in looking at all those statements they can figure out if they continue to make the minimum monthly payments, what that pay back will look like.
The other thing I would mention that they do immediately is pull a full copy of their credit report. People don't do that. I don't think enough to see what is on there and what information is accurate. And then I would have them really sit down and do an honest budget of what they think they can really put toward this debt.
And if again that dollar comes out to they're just continuing to make those minimum monthly payments, I think they need to take a very hard look at what they're doing today and realizing if they don't make a change of some types, whether it's consumer credit accounts, whether it's getting a new loan to secure better terms. Or even looking at that settlement, I think they need to take a good honest look at that.
Hoff: All right, fantastic. And finally, what gets you charged up about managing and eliminating debt?
Smith: I think it's more perspective. We've been in the mortgage space, we've dealt with ultra high net worth individuals and we really feel that this market is an underserved market. Everyone is so focused on the people with money, and how do we extra money from the people with money. No one's really focusing on the people that are really highly leveraged, and how do we help them, and how do we help them get to that next level.
And so we really enjoy working with people. I mean, we get emails on a daily basis about how we've changed people's lives and how one day they got something in the mail from us, it was something that changed everything that they look at going forward. And that's what really gets us fired up.
And when we look at how many consumers, I mean, I think we've settled half a billion dollars for 400,000 consumers through this program. So we've really changed the lives of a lot of people, and I think that's really what at the end of the day gets us keep coming back in and talking to people.
Hoff: All right, fantastic. Thank you so much for joining us today. A lot of great information. I encourage people to read your book and read more about your journey into this space as well as get tips and hear about other individuals who have faced debt and what they did to overcome it. Thank you so much, Brad, for joining me today.
Smith: Jenny, thank you. I appreciate your time.
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