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Client Log InDebt Settlement vs Bankruptcy
The processes of debt settlement and filing for bankruptcy represent two viable alternatives for an individual buried under insurmountable debt.
While choosing between one or the other may be akin to the feeling of being caught between a rock and a hard place, there are positives to be accrued in either approach. In this article, we will describe both processes while comparing and contrasting the virtues and drawbacks of each
Related to: Debt Settlement and Bankruptcy
The Basics of Debt Settlement
Debt settlement takes place when a debtor successfully negotiates a payoff amount for less than the total balance owed on a debt. This lower amount is agreed to by the creditor or collection agency and is fully documented in writing. Ideally, this lower negotiated amount is paid off in one lump sum, but it can also be paid off over time.
Even though it may seem surprising that banks would settle for less than what is owed, the statistical certainty that not all borrowers will actually pay back is built into a bank’s carefully formulated lending model. Understanding this reality makes it easier for many debtors to pursue debt settlement.
The process of debt settlement focuses primarily on unsecured debt, such as credit cards. Additionally, creditors are more likely to settle once a debtor has already demonstrated an inability to pay.
Therefore, if you’ve already fallen behind on payments by four or five months, it could be the ideal time to begin negotiating with creditors for the best settlement, as the bank still controls your account but also knows that the clock is ticking closer to charge-off, the point at which it would likely never recover anything from the delinquent account again.
Consequences of Bankruptcy
Bankruptcy should not be entered into lightly without an understanding of its long-term consequences. A Chapter 7 bankruptcy will remain on a credit report for ten years from the filing date, and a Chapter 13 bankruptcy will remain on a credit report for seven years from the filing date.
Either can impede a borrower’s ability to obtain new lines of credit, and potential landlords and employers may frown upon this aspect of a financial history. It is likely that a bankruptcy discharge will lower a FICO credit score toward the low 500s.
However, with careful planning and responsible financial behavior, particularly in the first two years following a bankruptcy discharge, it is possible to rebuild a FICO credit score to healthy levels following bankruptcy.
Debt Settlement vs Bankruptcy
Should I Pursue Debt Settlement or Bankruptcy?
The choice between debt settlement and bankruptcy will depend upon your aggregate debt level, the nature of your debt (unsecured vs. secured), your income, and additional considerations such as potential tax consequences and credit score impact.
For instance, even if your total debt level is high, if most or all of the debt is unsecured, debt settlement may be your best option. However, if you are carrying onerous secured debt (such as a home mortgage or auto loan) as well, pursuing bankruptcy could be the better option.
Regarding discretionary income, if you are able to put aside a certain fixed amount each month for an eventual settlement payment, then you can consider debt settlement. However, if you’re finding it unrealistic to accumulate any savings after accounting for basic necessities each month, then pursuing bankruptcy may be better. Do note that you will still need to meet certain income conditions to qualify for filing either Chapter 7 or Chapter 13.
Next, if you’re looking to reduce your debt burden related to certain private student loans (a form of unsecured debt), then debt settlement could work in your favor, as it is difficult to discharge private student loans through bankruptcy. Finally, regarding tax consequences, debt settlement savings in excess of $600 are considered a federally taxable event. However, this is not the case with bankruptcy, as discharged debts are usually not considered taxable income.
If you find yourself saddled with too much debt, regardless of how difficult things may feel today, there is a pathway out toward financial wellness. Regardless of whether you choose to pursue debt settlement or bankruptcy, you can effectively position yourself to secure a new unsecured credit line within two years of completing either. Contact us here at United Debt Settlement to discuss your various options as they relate to your specific financial situation.