Is Bankruptcy Better than Debt Settlement?

There’s a moment when most debtors suddenly realize they can’t pay their debts any longer. They have struggled for months—maybe even years—to make ends meet. At some point, however, there’s no denying it: You will never get on top of your debts.

Now is the time to do something. This article looks at two options for indebted people: debt settlement and bankruptcy. AtResolve Law Firm, we help debtors dig out from under their debt avalanche so they can finally see sunlight again. Let’s compare debt settlement with bankruptcy and explain why bankruptcy is almost always the better option.

What is Debt Settlement?

This is a technique to get creditors to accept less than the full amount of debt in exchange for a lump sum. The creditor then writes off the unpaid amount.

Imagine you have a credit card with a $10,000 balance. You can’t make your monthly payment, which is $400. So you offer to pay off $5,000 if the creditor will forgive the remaining $5,000.

To be successful with negotiations, you’ll need some money saved up to offer the creditor. Without a lump sum, a creditor has few incentives to agree to reduce the amount owed. However, a pot of money is tempting—although it’s hard for many people to save up thousands of dollars.

Why do creditors agree to debt settlement? One fear is that you’ll file for bankruptcy. If you do, then they might end up receiving almost nothing if you file for Chapter 7. A few thousand dollars can look attractive compared to $0.

How Debt Settlement is Worse than Chapter 7

You can file forChapter 7 if your income is below the state’s median for a family of your size. In 4-5 months, you can completely eliminate qualifying debts. It’s that easy.

Debt settlement is different:

• Debt settlement usually costs more. Although everyone’s situation is unique, we rarely see a situation where a Chapter 7 filer ends up losing more than they would by negotiating a debt.
• Debt settlement can take longer. There’s no guarantee your creditor will agree to cut a deal with you. You might negotiate for months and get nowhere, only to end up sued by a creditor.
• Debt settlement won’t save your credit. Don’t avoid filing for bankruptcy out of fear that you’ll ruin your credit. Once you settle a debt, the creditor will report “debt settled for less than the amount owed,” which will hammer your score.
• Any forgiven debt will count as income. Let’s say you owe $20,000 and settle for $10,000. That means you’ll need to report the forgiven amount on your tax return—and the IRS considers it income! Consequently, you’ll pay taxes on the amount forgiven. Any amount discharged in bankruptcy is not counted as income.

Even if Chapter 7 isn’t right for you, a Chapter 13 bankruptcy might still work better than debt settlement. You gain the protection of the automatic stay and can hammer out a rational payment plan. At the end, certain unpaid debts will be eliminated.

Debt Settlement Makes Filing Bankruptcy Harder

Some people settle a few debts only to realize they haven’t addressed their entire debt problem. Suddenly, they realize they’ll also need to file for bankruptcy.

Guess what? If you file for bankruptcy, whatever debts you paid might be voided as preferential by the trustee. That means the trustee will claw back the money you paid to settle a debt, and you could end up with an angry creditor. Please meet with an experienced bankruptcy lawyer before going down the debt settlement route. You need to think through whether it’s the best option for you.

Your Creditors Can Sue You in a Debt Settlement.

When a debtor files for bankruptcy, the automatic stay goes into effect. This stay prevents any creditor from taking collection actions against you. That means no wage garnishment, lawsuits, foreclosure, repossession, or even phone calls at home—at least for the duration of the bankruptcy.

Unfortunately, if you engage in debt settlement negotiations, nothing stops your creditors from going after you. In fact, they might beat you to the courthouse and get a judgment against you, and then put a lien on your property. It’s hard to avoid a lien in bankruptcy, which means you could end up losing your home or other real estate. Call an experienced Orange County bankruptcy lawyer to discuss which option is best.

Watch Out for Debt Settlement Firms

Many companies advertise debt settlement services on the internet or on television. They make all sorts of wild promises about saving their clients “millions” of dollars. However, these companies do not work for free. They usually charge a percentage of any amount of debt forgiven. So if they manage to get $40,000 forgiven, they might take half of that for their services.

This industry is largely unregulated. We can’t attest to the credibility or integrity of any debt settlement firm. Some pop up overnight before disappearing in a month or two. Some people involved don’t have the best intentions.

By contrast, Orange County lawyers are regulated by the state of California, and bankruptcy lawyers are overseen by federal judges. Lawyers can lose their license for unethical conduct. There is far less regulation for debt settlement companies.

When Debt Settlement Makes Sense

Despite the negatives, there are some situations where debt settlement can work. Let’s look at one: you want to file for bankruptcy but can’t.

Under the law, you can only file for a Chapter 7 bankruptcy eight years after having filed a prior Chapter 7. There is no getting around that type of delay. Perhaps trying to negotiate with creditors makes sense, although you have lost most of your leverage, which is the ability to file for bankruptcy protection!

Speak with an Orange County Bankruptcy Attorney Today

Resolve Law Firm is committed to helping members of the community free themselves from their debts. Call our firm to discuss your options in a free consultation. Instead of immediately signing up for debt settlement, get the facts you need to see if bankruptcy is the more sensible choice.