Bankruptcy vs. Debt Settlement: Important Things to Consider

Consider these options to help you gain back control of your financial future.

You've been quite consistent with making your debt payments, but months (and even years) pass, and you're still in a financial hole. Over the years, you've accumulated so much debt that it seems like it will take forever to pay off.

Or perhaps you've been trying your best to keep up with your payments, but you fall further and further behind because of bills and other important expenses. In either case, it's time to consider some options that will help you gain back control of your financial future. Debt settlement or filing for bankruptcy may be viable options. To decide which option is best for you, it's important to first consider your financial situation, the total amount of debt you owe, and other key factors.

Debt Settlement vs. Bankruptcy

What Is Debt Settlement?

Debt settlement, also known as debt arbitration, debt negotiation or credit settlement, is an approach to debt reduction in which the debtor and creditor agree on a reduced balance that will be regarded as payment in full. This is often done with a third-party company, in which they negotiate a settlement with your creditor or debt collector in order to reduce your debt. Debt settlement sometimes doesn't work for all outstanding debt such as mortgages and auto loans.

How Does Debt Settlement Work? Will It Impact Your Credit?

Debt settlement companies typically contact your creditors for you and negotiate for a lump-sum payment that's less than the amount you owe in order to reduce or settle your debt. The debt settlement company usually charges a fee, which is often a percentage of the amount you saved on the settled debt. During the negotiation process, you may be required to either make regular deposits into an account to save money towards your lump-sum payment or you may be advised to stop paying your creditors until a debt settlement agreement is reached.

[Make sure you understand every option available. Here's how bankruptcy protects you and stops creditor harassment.]

After the debt settlement company and your creditors reach an agreement, you must make at least one payment towards the settled amount, Then, the debt settlement company will begin charging you fees for their services.

During negotiation, the debt settlement company may advise you to stop making payments on your debt so that you can save for a lump-sum payment. However, your creditors have yet to agree to anything. Unfortunately, you may end up with delinquent accounts on your credit reports. As a result, your credit scores will decrease as creditors may send your accounts to collections or sue you for the debt.

What Are The Potential Results Of Debt Settlement?

There are several debt settlement outcomes you could potentially face:

• The creditor doesn't agree to a settlement at all. This is perhaps the worst-case scenario when it comes to debt settlement. There is no guarantee that the debt settlement company will settle all of your debts.
• The creditor does agree to a settlement, which is the ultimate goal. However, if the debt settlement company has advised you not to make payments on the debt while negotiations took place, your credit score may take a hit.
• The debt settlement company has only settled a portion of the total amount owed. For example, you owe $10,000, but the debt settlement company was only able to settle $5,000. In cases like these, you may still have to pay the debt settlement company a portion of their full fees even if your whole debt wasn't settled. 
• You may suffer tax consequences. If the amount of debt forgiven exceeds $600, the creditor will report this to the IRS. The IRS will consider this income and require you to list it on your tax return. This could either cause you to owe more taxes to the IRS or cause a lower refund amount.

Why Bankruptcy Is A Better Option

When filing for bankruptcy, you don't have to worry about paying a debt settlement company. In addition, bankruptcy stops collection calls, lawsuits, and wage garnishments, all things that debt settlement doesn't guarantee to stop. Bankruptcy also protects you from paying taxes on a forgiven amount of debt. 

[People often worry if their neighbors or friends are going to find out they filed for bankruptcy. There are very few ways someone could find out. Watch and learn to see why.] 

Bankruptcy is also a good option for you if:

• You can't save enough money to settle your debt.
• You have more than credit card debt.
• You're going through hardship (i.e. medical problems, lost your job, etc.).
• You won't be able to afford your other bills.
• Creditors don't want to negotiate with you.
• Creditors learn you can't pay, they might file legal actions aimed at garnishing your wages.

Advantages Of Bankruptcy

Jaromir Nosal - assistant professor of Economics at Boston College - co-authored a study for the Federal Reserve Bank of New York about the effects of bankruptcy. He found that consumers typically recovered rapidly from bankruptcy and were more likely to be granted new credit lines within 18 months than people who fell behind 120 days or more overdue at the same time but didn't file. 

While bankruptcy can have a negative impact on your credit score, as time goes on, the impact of bankruptcy on your score will decline.

[Check out our Bankruptcy FAQ for answers to common questions about bankruptcy.]

When you file a Chapter 7 bankruptcy, most of your property is sold in order to pay off your debt. It is a viable option for people who don't have the ability to pay back all or some portion of their debts. 

With a Chapter 13, debtors are allowed to keep their property if they adhere to a court-mandated repayment plan, which allows you to pay your creditors a portion of the outstanding debt over a fixed period of time. Depending on your income, the repayment period can be three or five years. During this period, you can rebuild your credit by making on-time bill payments and managing your debts smartly.

How To Decide

Whether you choose to go with debt settlement or bankruptcy, you've taken a big step towards reducing or settling your debt altogether. However, you should do extensive research to find the best path for you. Are you looking to get rid of your debt faster and with less of a hit to your credit? Debt settlement may be a good options. Are you unable to make payments towards your debt and are you willing to let your credit take a huge hit? Consider filing for bankruptcy.

Whatever your situation, at Woodall & Woodall, we're here to help. Request an appointment to see which option is right for you.

Mr. Woodall is a Managing Partner at Woodall & Woodall. He is a graduate from the University of Georgia and Florida Coastal School of Law, and has been practicing bankruptcy law in South Georgia since 2003. In 2018, Mr. Woodall was selected as one of the top 20 bankruptcy attorneys in Georgia Trend Magazine's Legal Elite. Contact Will here.