Debt settlement versus filing for bankruptcy: Which makes more sense for you? A lot of my clients consider each to resolve their debt problems and don't know which way to go. There is no right answer. It is important to know the benefits of each before you jump into it. Once you have educated yourself, it is easier to make the turn.
1. Cost. A fairly straightforward Chapter 7 consumer filing could cost anywhere from $1,300 to $2,000. This includes costs like the court filing fee, credit counseling, debtor education course and a credit report. A Chapter 13 is generally around $3,000 in attorney fees and about $450 in costs. However, in a Chapter 13, your attorney fees are rolled into the monthly repayment plan and your unsecured creditors usually end up paying it. In a debt negotiation, it is usually about 10% of the debt being negotiated in addition to any monthly fees and must be paid up front before any work is done.
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2. Tax Consequences. There are no tax consequences to discharging debt in either a Chapter 7 or Chapter 13 bankruptcy. Any debt reduced by direct negotiation with a creditor will result in a tax liability. You will get a 1099c for the amount of debt forgiven if it is more than $600. For example, you owe Visa $10,000 and settle for $3,000, you will get a 1099 for $7,000 and will have to pay taxes on it.
3. Credit Reporting Effect. A Chapter 7 bankruptcy will stay on your credit report for 10 years. A Chapter 13 is 7 years. An uncollectable, negotiated, or written off debt will stay on your credit report for 7 years. However, the effect on your credit score may not matter if you are considering either. On a side note, I have seen that a bankruptcy usually improves my client's credit score and that most of my clients get credit card and auto loan offers soon after filing. Why? Because they don't have any debt and can't file bankruptcy again anytime soon.
4. Regulations. Attorneys are licensed to practice law and must report all fees charged to the court. Fees are approved by the judge and if not earned or too much, the attorney may be ordered to refund the client. Debt negotiators are not licensed, do not have to have any special qualifications, and are not regulated.
5. Creditor Harassment. Once you file for bankruptcy protection, all creditor harassment must stop because of the automatic stay. Any relief sought by a creditor must be before the bankruptcy court. They may not call you; write you; or contact your family, friends, or your job. They cannot sue you or continue a lawsuit. They cannot garnish your paycheck, bank account, or tax refunds. If they violate the automatic stay, you may be entitled to money damages. When you are negotiating a debt, the creditors may do all of the above without restriction.
6. Effectiveness. A successful bankruptcy eliminates debt except for things like domestic support obligations, some income taxes, and student loans. You will get a court order discharging the debt. In a Chapter 7, maybe in as little as four months after filing. In a Chapter 13, after your payment plan which can typically last anywhere from three to five years. A bankruptcy usually resolves all of your debt issues. A Chapter 13 can save your house from foreclosure or stop a car repo and even get rid of a second or third mortgage. In a debt negotiation, each creditor will be negotiated with individually with focus on the word "negotiate." You have no right to negotiate your debt. None. Doesn't exist. I have heard the ads, too. I have also read the law. You do not have a right to negotiate a debt. Bankruptcy is a Constitutional right. Creditors must participate. The debt is eliminated whether or not they like it.
7. Privacy. A bankruptcy filing is public record and, while unlikely, anyone can find out about it. A credit management is private except for the notations on your credit report.
8. Payment Plans. There is no payment plan in a Chapter 7. If you are eligible, you will get a discharge with no further payments. A Chapter 13 is a lot different in that you determine what your monthly living expenses are and your disposable income is paid to your creditors for the length of the plan. In a debt management plan, you are told how much you have to pay and then have to budget your life around it. These are opposite concepts. In a debt management plan, your monthly payment is the priority debt. In a Chapter 13, payment to your unsecured creditors has the lowest priority.
Unfortunately, I don't know about all the successful debt management plans people do because I get the people that get ripped off, that are getting sued by the creditors after an agreement is reached, or can't afford the monthly or lump sum payments required by their creditors. I can tell you bankruptcy absolutely works and that is the one thing that your creditors don't want you to know.
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