Debt Settlement v. Bankruptcy
Sometimes I get calls from people asking me about the benefits of debt settlement over bankruptcy. My answer, as always, depends on the individual’s situation, but usually bankruptcy is going to be the best way to go. Let me explain.
Let me make it clear that I’m not talking about consumer credit counseling when I use the term “debt settlement.” I’m talking about someone hiring an attorney to act on his behalf to contact creditors and negotiate settlements directly with the creditors. I’m not talking about contacting a credit counseling agency that negotiates lower interest rates and administers a “debt repayment plan” or “DRP.” I’m referring to negotiating the entire account at a percentage on the dollar.
Not everyone is a candidate to negotiate a settlement with creditors. Negotiating settlements requires the payment of a lump sum of money. If you are a person that doesn’t have any access to some cash, then you are not a candidate for debt settlement negotiation. You’ve got to have access to some cash, obviously your access to cash would not have to be enough to pay off 100% of your balances. If you could do that, you wouldn’t need any help. I’m talking about a situation where you might have a family member who can give you a limited amount of money, or maybe you have a pension plan you could take some money out in the form of a loan. No matter the source, you have to be able to get your hands on some cash that you can use to pay lump sum payments to your creditors for the negotiated amount.
A “lump sum” payment could be a payment over two or three installments in a relatively short amount of time, so it may consist of more than one payment, but you’re not going to be able to get a creditor to reduce it’s principal balance and eliminate the interest if you are proposing to pay payments over 5 years or something, the creditor would just as soon force you to file for bankruptcy than agree to that. The point is that you must be able to get the cash to the creditor in a very short amount of time, usually within 30-45 days.
If you are a person who could qualify for a debt settlement negotiation because you have some quick access to a limited amount of cash, then you can sometimes have your debts successfully negotiated down to $.35-.70 on the dollar. Every creditor is different as far as how much they are willing to take so there isn’t going to be a set result you can count on. That’s one of the disadvantages of debt settlement. If all your creditors agree and the last one won’t take any settlement, that can often blow your plans out of the water and force you to file for bankruptcy anyway, after you’ve wasted thousands of dollars paying the other creditors. So, there is a risk associated with settling the debts. No one can guarantee you the result and you’re just trying to get the best deal you can. The bottom line is you can expect to have to pay around $.50 on the dollar so you’ll need enough cash to cover that.
Also, what many people don’t realize is that the portion of the debt you don’t pay back to your creditors you must include on your tax return as taxable income, arguably, in the year of the settlement. Thus, if you negotiate an average of 50% settlements, you actually are paying that 50% to the creditors directly AND you are paying the IRS taxes on the “forgiven” portion at your tax rate. Also, depending on how much debt is involved the amount of the “forgiven” debt could be high enough to bump your tax bracket up forcing you to repay more.
Debts you discharge in bankruptcy are NOT taxable income. Also, bankruptcy, even a Chapter 13 repayment plan, doesn’t require you to come up with lump sums of money. Bankruptcy also can FORCE creditors to accept payments involuntarily, whereas a settlement negotiation requires the creditor to voluntarily agree. For these reasons, in most situations, filing bankruptcy is going to be better than negotiating a settlement.
