- 7 min read
- Bankruptcy & debt settlement offer aggressive strategies for resolving overwhelming debt.
- Bankruptcy is a public process, and debt settlement is private.
- Debt settlement and chapter 13 may cut your monthly debt payments.
Which is better, filing bankruptcy or signing-up for a debt settlement plan? The answer depends on your debts, your circumstances, and goals. One potentially confusing thing about bankruptcy is there are two forms of bankruptcy for consumers, which are quite different. We’ll compare both forms of bankruptcy to debt settlement, and point out significant differences of each, and how these differences might matter to you.
Let’s talk about bankruptcy first. A federal bankruptcy court supervises every bankruptcy. Once you file your bankruptcy application (called a petition) with the court, no one can file a lawsuit against you. Any lawsuit pending against you must pause while the bankruptcy court is in charge of your case. There are many forms of bankruptcy, but two apply to most consumers. The first, called a chapter 7, discharges all of your qualified debts several months after you file. The second, called chapter 13, puts you into a payment plan for 3 to 5 years, after which your remaining qualified debts are discharged completely.
Now let’s turn to debt settlement. Debt settlement is not court-supervised. Instead, you make monthly deposits into a special savings account while your debt settlement partner negotiates deals on accounts you enrolled in the debt settlement plan. Plans typically last 3 to 4 years, during which you pay each creditor 40 to 60 cents on the dollar to resolve your debts.
Note that neither debt settlement nor bankruptcy will eliminate or reduce your child support payments. If you cannot afford your alimony or child support payments, you need to return to the court that set your payment amount and ask for relief there. Both bankruptcy and debt settlement negatively impact on your credit score (more on this later).
Bankruptcy Pros & Cons
Bankruptcy is designed to give consumers and businesses a fresh start. As mentioned, consumers can file for either a chapter 7 or chapter 13 bankruptcy. You must take a means test to learn if you qualify for a chapter 7 or chapter 13 bankruptcy. If your amount of debt is very, very large, you will qualify for chapter 7. If your amount of debt is just large, then the court will direct you into a chapter 13. The court uses the means test to determine which chapter applies to you.
Consider bankruptcy when you:
- Have an aggressive creditor who filed a lawsuit against you, or you are reasonably certain is about to file a lawsuit against you.
- Live in a state without anti-deficiency rules and plan to allow foreclosure on your property.
- Wish to stop a repossession on a home you hope to keep.
- Love your home, which is hopelessly underwater, and you want to discharge your liability for a second mortgage.
- Owe a very large debt you cannot pay in a reasonable period of time.
- Cannot afford private student loan payments for an amount the lender will not negotiate reasonably.
- You owe an unusual or rarely negotiated debt, such as civil judgments and overpayments from Social Security Administration or the VA.
Check out your debt options
Talk with an expert about your debt resolution options. Complete this brief form and a Bills.com debt resolution partner will call you to help you find a way to solve your issues with debt.
Bankruptcy is not for everyone. Avoid bankruptcy when you:
- Are told by your supervisor at work or human resources team that filing bankruptcy will jeopardize your security clearance.
- Value your privacy and do not want your bankruptcy to be become part of the public record. However, as a practical matter, unless you’re a celebrity, your friends and family will not be aware of your bankruptcy case.
- Filed bankruptcy recently.
- Plan to qualify for home loan in the next two years. Most home-loan lenders will not approve a loan when one of the borrowers has a discharge that has not "seasoned" for 2 years or more.
- Plan to qualify for a lease in the near future. Landlords have inconsistent policies on recent bankruptcies.
Bankruptcy appears on your credit report for 10 years. Its impact on your credit report is harsh and swift. However, over time the impact of bankruptcy fades, and after 6 or 7 years of positive history, the impact on your credit score will fade completely.
After the table, we help you decide when to choose or avoid debt settlement.
|Creditors may not file a lawsuit due to automatic stay.||In a chapter 13, you will be on a court-supervised budget for 3 to 5 years.||Pick and choose which accounts to include. You can keep some credit cards active.||Possible tax consequences due to 1099-C. However, this can be dealt with using the IRS CODI process|
|Eliminates personal liability for most debts.*||Bankruptcy information is a public record.||One payment will resolve multiple accounts.||Possibility of hidden costs.|
|Chapter 7 bankruptcy can discharge debts in less than a year.||Ineligible for FHA, Fannie Mae, and Freddie Mac loans for 2+ years.||Lower monthly payment than your existing payment||Possibility of lawsuit. Can be dealt with by partnering with a debt settlement provider with a legal negotiation team.|
|Lawyer fees may be less than debt settlement fees, depending on debt size.||Future landlords can discriminate against bankruptcy filers.||Private. Not part of the public record.||Longer process than chapter 7, about the same length as a chapter 13|
|* Usually cannot discharge child support, fraud-related judgments, federal student loans, and some tax debt.|
Bankruptcy and Debt Consolidation Pros & Cons. Source: Bills.com
Debt Settlement Pros & Cons
Debt settlement is called by different names, including debt consolidation and debt resolution. In debt settlement, you stop paying your creditors directly and instead put money into a savings account that builds over time. As this account grows, your debt settlement company negotiates lump-sum settlements for your enrolled debts. Several years ago, the FTC set rules stating a debt settlement company cannot charge customers a fee until it makes a settlement. Avoid any debt settlement company that charges up-front fees.
Consider debt settlement when you:
- Have common types of debt, such as credit card, medical, or deficiency balance debts.
- Want to cut your monthly debt-related payments.
- Need to keep non-enrolled credit cards active.
- Cannot file bankruptcy due to security clearance concerns or related reasons.
- Are a celebrity, or otherwise do not want your debt resolution to become public information.
- You wish to qualify for a home loan or lease in the near future.
Debt settlement is not for everyone. Avoid debt settlement when you:
- Have no breathing room in your budget for making a monthly deposit into your debt settlement account, and otherwise qualify for a chapter 7.
- Have only secured debt, such as auto loans or mortgages.
- Have loans where the lender has the right to offset your other accounts. In other words, your lender can drain your savings or checking account if you fail to make an auto loan payment.
- Have a reasonable belief the creditor will file a lawsuit against you if you fail to repay the loan as agreed.
Some creditors file lawsuits against consumers who do not repay their loans. But most are reasonable and welcome a consumer making an organized effort to settle a debt. So you know what to expect, talk to your debt settlement candidates to learn if your creditors are aggressive, or more reasonable.
Debt settlement also has a negative impact on your credit score. However, according to Fair Isaac & Co., the creator of the FICO credit score, the impact of debt settlement is less than bankruptcy.
Final Analysis: Bankruptcy & Debt Settlement
If you ask a carpenter, "Which is your best tool?" he or she will likely reply, "The one most appropriate for the job." Bankruptcy and debt settlement are both good tools. Which is most appropriate for you depends on your circumstances. Review all of your debt resolution options and under their their strengths and weaknesses before you choose one. By doing so, you are more likely to achieve a successful outcome.
Bills Action Plan
- Use the Bills.com Debt Coach tool to review the costs of debt consolidation, bankruptcy, and your other options.
- Consult with a bankruptcy lawyer to review your qualifications for chapter 7 or chapter 13
- Talk to a Bills.com debt consolidation partner to get an estimate of your monthly payments for a debt settlement plan
- Follow-through on your plan.
Did you know?
Debt is used to buy a home, pay for bills, buy a car, or pay for a college education. According to the NY Federal Reserve total household debt as of Q2 2023 was $17.06 trillion. Auto loan debt was $1.582 trillion and credit card was $1.031 trillion.
According to data gathered by Urban.org from a sample of credit reports, about 26% of people in the US have some kind of debt in collections. The median debt in collections is $1,739. Student loans and auto loans are common types of debt. Of people holding student debt, approximately 8% had student loans in collections. The national Auto/Retail debt delinquency rate was 4%.
Each state has its rate of delinquency and share of debts in collections. For example, in Kansas credit card delinquency rate was 3%, and the median credit card debt was $445.
Avoiding collections isn’t always possible. A sudden loss of employment, death in the family, or sickness can lead to financial hardship. Fortunately, there are many ways to deal with debt including an aggressive payment plan, debt consolidation loan, or a negotiated settlement.