Is Debt Settlement a Better Alternative to Bankruptcy?

The basics of debt settlement

The formula for debt settlement is simple: hire a debt settlement company, stop paying your creditors, save up funds to use for settlement, then make offers with your creditors for pennies on the dollar.  It sounds like a great alternative because it keeps you out of bankruptcy, but beware of the fine print.

You can be sued in debt settlement

Debt settlement requires you to stop making your regular monthly payments to creditors. However, when you stop paying your creditors, you can be sued for the full balance of what you owe and even additional amounts for their attorney fees. If a creditor gets a judgment, the judgment is an automatic lien on any real estate you own, and they can even seize your assets to satisfy the debt. The lawsuits will only stop only after settlements are reached with your creditors, and it can take years before you’ve saved up enough to settle. Even then, your creditors are not obligated to settle with you. With bankruptcy, your creditors cannot prevent you from filing, lawsuits are stopped immediately with the automatic stay, and your creditors are required to obey the bankruptcy court order discharging your debts.

Bankruptcy is cheaper

In debt settlement, creditors settle based on a percent of what you owe. If you have a lot of debt, this can drive the cost of debt settlement to an unaffordable monthly payment. The balance of what you owe can even go up until the debt is settled. With debt settlement, you never know what the final cost will be until the last debt is settled years down the road. Chapter 7 bankruptcy will always cost less than debt settlement because there are no monthly payments at all. In a Chapter 13 bankruptcy, if your assets don’t exceed your exemptions, your monthly payment is based on what you can afford to repay. You will also know early in the process what a Chapter 13 bankruptcy will cost. Almost always, your unsecured creditors will be paid less than what they will settle for in debt settlement.

Taxes            

When you cancel more than $600 in a settlement, the creditor will issue you a 1099-C for the difference between the current balance and the settlement amount. This may be treated as income that will trigger a higher tax bill on your income taxes. There are some exceptions to this, so speak with a CPA to see if this will apply to you. Filing bankruptcy does not trigger any income tax for the discharged debt.

The bottom line

Almost always, the only time I advise a client that debt settlement is a better alternative to bankruptcy is when they will lose assets in a Chapter 7 bankruptcy [find out what you can keep here] and when they can’t afford the payment in a Chapter 13 bankruptcy. Before attempting debt settlement, speak with me first for an honest assessment of your situation.

Are You Thinking About Filing Bankruptcy? Don’t Try These Three Things First.

When a client comes to me seeking help to file bankruptcy, many times they have tried something else first.  Whatever they tried didn’t work.  It was also time, money, and headache that could have been avoided.  Sometimes there are strategic reasons to wait to file bankruptcy.  But usually, the sooner you file bankruptcy, the sooner you eliminate your debts and begin making a financial recovery.

If you are considering doing one of these three things to try and get out of debt, call me first.  It may do more harm than good:

  1. Don’t try to make a debt settlement program work.

Bankruptcy is cheaper, takes less time, and stops lawsuits from your creditors.  If you sign up for a debt settlement program, your creditors aren’t getting paid and after a while they are likely to sue you.  This is usually about the time many of my clients decided debt settlement was not worth it.

  1. Don’t borrow money from friends and family.

You’ll feel morally obligated to repay them, and if you do, the court might view the repayment as fraudulent and your friends or family may have to give the payments back.  Do this and you may have to wait before you can file bankruptcy.

  1. Don’t use your 401(k) to pay down debt.

You’ll need the money for retirement and you’ll get to keep all of it when you file bankruptcy.  Use it to fend off your creditors before filing bankruptcy and you won’t get that money back.  It may also trigger tax consequences, and if you can’t afford the tax bill when it comes due, you may not be able to discharge the debt in a Chapter 7 bankruptcy.  If you file a Chapter 13 bankruptcy instead, it may increase the amount of your monthly plan payments.

Talk to me first.

Don’t try figuring it out on your own.  I will tell you if bankruptcy is the best option or if there is another solution that would work better.  These solutions might make sense if bankruptcy isn’t a workable solution.  Usually, it just delays the inevitable.  The longer you take until you file bankruptcy, the longer it will take to get a fresh start.