Debt settlement is an alternative to filing for bankruptcy relief. The typical process of debt settlement is contacting a creditor and offering them a payoff for less than the full balance owed. Typical settlements generally range from 20-50%. However, what debtors need to be aware of is that the creditor is under no obligation to accept a settlement. Moreover, the settlement amount varies from creditor to creditor and depends on such factors as the likelihood of the debtor paying the debt in full, the age of the debt, and how aggressive the creditor is.
In order for the debtor to get the lowest settlement offer, the debtor will need to be able to make the settlement offer in one lump sum payment. For example, if the debtor is trying to settle a $30,000.00 account and the debtor and creditor agree on a 40% settlement, the debtor would need to pay the $12,000.00 ASAP. For this reason, debt settlement is not a great option for people in dire financial trouble. Most debtors do not even have that much money in their bank accounts.
Many debt settlement companies do not fully explain how debt settlement works. You pay the debt settlement company a set amount each month. The company pays itself its fee out of those funds and holds on to the remainder as it accumulates in order that they have a lump sum to settle your debt. This takes about 4-5 months. It is around the tail end of that time that the debt consolidation company will start negotiating with creditors in regard to settling your debt. As stated above, creditors are under no obligation to settle a debt and many of the creditors will simply file a lawsuit suing you for the total money owed, plus attorney and court fees. This can evolve into a judgment against you that can attach to your home’s title. This will impair your ability to refinance or sell your home. Alternatively, they can get a bank levy and/or garnishment against you which will empty your bank account and/or garnish your wages in the amount of 25% of your gross wages each pay day.
It’s a better and less expensive option to pay a one-time, flat fee to a Chapter 7 Bankruptcy Attorney to wipe out all your debts rather than pay creditors incrementally.
Debt Consolidation and its Disadvantages
Debt consolidation is another alternative to bankruptcy and is different than debt settlement. Debt consolidation companies tell you to pay an agreed-upon amount to the debt consolidation company each month, most of the time through an automatic payment through your checking account. The company keeps a certain amount as their fee. The remainder goes into a pot of money and is eventually used to attempt to settle your debts. The key word is eventually. They do not settle your debts right away at all. They keep this money in a reserve amount and slowly settle out debts with each creditor. If you are in a monthly payment plan with a debt consolidation company for the next 3 years, the company may not settle certain debts until year 3. Here is the major downside, your creditors are NOT being paid during the entire time. This means, you will be delinquent and end up filing a lawsuit against you, even though you have been diligently paying the debt consolidation company.
Most debt consolidation companies are a scam or don’t actually tell you that they won’t be paying your creditors monthly. They gloss over the fact that you could be sued while making monthly payments to their company.
Another disadvantage of debt consolidation is the same as with debt settlement, which is the tax consequences. The IRS can require you to pay taxes on any amount of debt that was forgiven during the debt consolidation process. When you file for Bankruptcy, there is a section of your tax return showing that you are insolvent and all the debt that was discharged is not considered income and therefore not taxable.
Bankruptcy is 100% a better option if you qualify. You are completely protected against creditors suing you or taking any action against you. And you can wipe out all your debts in Chapter 7 vs paying them back over a long period of time.