DEBT SETTLEMENT VS BANKRUPTCY: WHICH WILL GET ME OUT OF DEBT FASTER?
When someone’s finances become too much to handle, it’s common to look for other ways to manage debt. If you fall into that category, you might find success negotiating a lower payoff with creditors by going through a debt settlement company.
When you are plagued with overwhelming debt, you’re likely contemplating the pros and cons of debt settlement vs bankruptcy. Each option offers some advantages, but many disadvantages as well. But, before you decide, it’s wise to understand the advantages of both bankruptcy and debt settlement so that you can make an informed decision. Here’s a short introduction on the benefits and drawbacks of debt settlement vs bankruptcy, and some information on helpful alternatives.
WHAT IS BANKRUPTCY?
In bankruptcy, you’ll enter a legally binding process that will erase most of your debt and/or structure any repayments you have to make. Bankruptcy will effectively get rid of (discharge) many types debts, but not necessarily everything that you owe. You’ll likely want to start by reviewing your debts, and determining whether bankruptcy would provide the relief you need.
WHAT IS DEBT SETTLEMENT?
In a debt settlement program, you’ll stop paying your bills to creditors and when the amount of your back payments is quite sizable, you’ll offer to settle your debt for some portion of the total amount you owe.
A legitimate debt settlement company will help you set up a plan to manage your debts. Typically, you’ll make regular payments to the company, who will hold the funds in escrow while negotiating with your creditors.
However, you REALLY need to investigate the debt settlement company before you sign up because the debt settlement industry is rampant with scam artists. Even though they promise to keep client funds in escrow to pay settled debts, many don’t, and when the company folds, clients learn that the company has used their deposit to pay for marketing campaigns and operations.
Some red flags to look out for:
- High fees. You can expect the company to take their fee as a percentage of the money they save you when they negotiate a settlement with a creditor. A majority of your monthly payment may go to the debt consolidation company instead of your creditors. Sometimes the payments are structured in a way that you pay the debt relief company’s upfront fees first, while your credit report gets hit with a missed payment notification every month. This drives down your credit score even while you’re trying to settle your debts.
- Promises to fix your credit score. Debt settlement companies cannot fix your credit score by removing negative information unless it’s inaccurate. Any promises to the contrary are based on a process that requires the company to dispute the information even if it’s correct. Eventually, the correct negative information will pop back up on your report.
- Guaranteed results. Debt settlement companies cannot ensure that a particular creditor will settle any debt for any amount. None of your creditors HAVE to enter into a debt settlement deal. It is 100% voluntary on their part.
There are some good companies out there but you have make sure you do your homework!
DEBT SETTLEMENT VS BANKRUPTCY: THINGS TO CONSIDER
How Long Does the Process Take?
- Bankruptcy. A Chapter 7 bankruptcy usually takes about four to five months. In a Chapter 13 case, you’ll propose a repayment plan that can last from three to five years, depending on whether your family income falls below or above the median income for your state.
- Debt settlement.There’s no set time. It will depend on how long it takes you to negotiate a settlement amount and gather or save the money needed to pay it.
How Much Will It Cost?
- Bankruptcy. You can expect to pay a court filing fee of $310 for Chapter 13 bankruptcy and $335 for Chapter 7 bankruptcy. Attorneys’ fees that vary by region and complexity of the case and credit counseling and debtor education courses for $15-$30. You’ll also have to pay into a three- to five-year repayment plan in Chapter 13 bankruptcy.
- Debt settlement. The cost will vary depending on the result of your negotiations. Most creditors eventually settle for 40% to 60% of the balance but will likely require you to pay that in a lump sum.
Protection from Creditor Action
- Bankruptcy. Creditors cannot choose whether or not they participate in the bankruptcy case. It applies to all. Creditors cannot take action to collect their debts while you are under the protection of the bankruptcy court.
- Debt settlement. Creditor participation is voluntary. Until you reach a settlement, creditors are free to take whatever collection action they’re allowed by law, including filing a lawsuit. Creditors can cancel the agreement at any time. Sometimes creditors change their minds and decide to pursue other legal remedies to collect the debt, even if you are current on your payments to the debt consolidation company.
Effect on Credit
- Bankruptcy. Chapter 7 bankruptcy will appear on your credit reports for ten years from filing. A Chapter 13 case will remain on your credit report for seven years after filing.
- Debt settlement. Negative information about your accounts will remain on your credit report for seven years. Settling a debt instead of paying the full amount can affect your credit scores. When you settle an account, its balance is brought to zero, but your credit report will show the account was settled for less than the full amount.
- Bankruptcy. You won’t have to pay tax on a debt discharged in bankruptcy. The Internal Revenue Service doesn’t treat this type of debt as income.
- Debt settlement. The creditor can report the unpaid debt on IRS Form 1099-C (cancellation of debt), which the IRS will treat as income unless certain conditions are met. Therefore, you stand to pay income tax on the forgiven amount.
GETTING ADVICE ON DEBT SETTLEMENT VS BANKRUPTCY.
Neither bankruptcy nor debt settlement is a simple process. That’s why, when considering debt settlement vs bankruptcy, it’s important to seek financial advice from a certified credit counselor. Bankruptcy and debt settlement are just two options to consider when you’re trying to deal with the debt monster. If you’re strapped financially because of a job loss or unexpected illness, bankruptcy may be the only light at the end of the tunnel. Debt settlement, on the other hand, may be the better choice if you want to minimize the impact on your credit and you think you can repay your debt in a few years. Weighing the pros and cons of each option carefully can help you find the best fit for your situation
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