Bankruptcy vs Debt Settlement
What You Need to Know about Bankruptcy vs Debt Settlement
An an attorney that has worked in both bankruptcy and debt settlement for 20 years, I’m asked every day about the advantages and disadvantages of debt settlement versus bankruptcy. If you are looking for options on getting out of debt, chances are, you would like to compare the relative advantages of bankruptcy versus debt settlement.
First, I would like to point out that it is always best to visit with an experienced bankruptcy attorney before making any major decision with respect to your debt. I would also invite you to call me directly at 303-872-8492 to go over the details of your particular situation so that I can go through the comparison with you.
Below, I will outline some of the basic differences, but understand that this is no substitution for a personal appointment with a qualified attorney.
Chapter 7 Bankruptcy vs Debt Settlement
There are 2 types, or “chapters” of bankruptcy which apply to most consumers, Chapter 7 and Chapter 13. They are very different, so each deserves its own comparison to debt settlement. Chapter 7 Bankruptcy and Debt Settlement, generally speaking, are two totally different solutions for two totally different types of clients. In a Chapter 7, clients are required to have low income and few assets. To qualify for Chapter 7, you have to pass the “means test”. To pass, your income must be, in most cases, at or below the state median income by family size for the state in which you live. In some cases, if you are a little bit above the median income you can still pass. Visit your bankruptcy lawyer to find out for sure. Here is a list of median income by state: www.usdoj.gov
Debt settlement clients, on the other hand, generally have higher income and some savings available to settle their debts with. So these two options are almost mutually exclusive. If you earn below the median income for your state, chances are, you do not have enough money to be a viable debt settlement client. In some rare cases, a client who qualifies for Chapter 7 can borrow the money to settle from a relative. I generally don’t recommend this, because owing friends and family can create a whole new type of problem.
Chapter 13 Bankruptcy vs Debt Settlement
Chapter 13 Bankruptcy, on the other hand, is often a solution that “competes” head to head with debt settlement, because both involve a repayment plan to your creditors. First, lets look at Chapter 13 in more detail.
What is Chapter 13 Bankruptcy?
Chapter 13 is called “debt adjustment.” In a Chapter 13 case, you are required to make one monthly payment to the Chapter 13 Trustee, to repay some portion of the debt you have. You file a “plan” showing how you will pay off some or all of your past-due and current debts over three to five years. A Chapter 13 is used for individuals or couples with high income, tax problems or face foreclosure.
Pros of Filing Chapter 13 Bankruptcy
You force a payment plan on your creditors that works for you. You are not required to repay 100% of your debt. In fact, some plans call for payment of less than 10 cents on the dollar.
Cons of Filing Chapter 13 Bankruptcy
There are many downsides to a Chapter 13. You have to propose a repayment plan and a budget to the Chapter 13 trustee, who may be strict ( I.e., no dining out). You go to a hearing where the Trustee or their attorney examines your budget and almost always tries to squeeze more out of you. You must justify what you spend your money on each month. The Trustee gives you very little room for error, so if you have an emergency expenditure, you may get behind on your monthly Chapter 13 payment. What happens to so many people is that their Chapter 13 case gets dismissed and they get thrown back to the “wolves” – their creditors. Now they have a “bankruptcy” notation on their credit, but they never got the benefit of a discharge of debts! The last time we checked, the percentage of Chapter 13 filers who successfully completed their plan was less than 40%! Also keep in mind that when you file a Chapter 13, you must include all of your credit cards. You cannot leave one or two out for convenience purposes (e.g., getting a plane or hotel reservation).
The Optimal Candidate for Filing Chapter 13 Bankruptcy
Chapter 13 may be the best solution if:
- you own your home and you are in danger of losing it to foreclosure, but you could get caught up if given time;
- you are behind in your automobile payments, but can catch up if given time;
- you have valuable nonexempt property which you would like to retain and you can afford to pay creditors from your income over time;,
- you have debts which are dischargeable in Chapter 13 but not Chapter 7 (e.g., debt incurred through fraud);
- you owe the IRS or the state for taxes.
In some cases, if you have high income and an ability to repay your debts over time, you may not be permitted a discharge in Chapter 7 and Chapter 13 is your only bankruptcy option. In this case, be sure to consider debt settlement as an option as well.
If you would like to consult a bankruptcy attorney, go to the bankruptcy referral part of this site.
So here are some factors to consider when you are comparing the relative benefits of Chapter 13 and Debt Settlement:
First, you want to know what your repayment percentage will be in a Chapter 13 plan, because this varies wildly. If your potential plan is a 20% repayment plan, it would certainly be cheaper to you than a typical debt settlement plan which repays 50-65%. On the other hand, if your potential Chapter 13 repayment plan is a 100% repayment plan, then debt settlement would be a cheaper way to go.
How do you know how much you will repay in a Chapter 13? Generally, you will need to go to an attorney experienced in Chapter 13 and see what her estimate is based on her experience filing 13s in the state you live in. The payment is basically calculated by taking your net income, less your reasonable and necessary monthly living expenses (not counting credit card payments and other unsecured debt payments). So if you make a lot of money, then you are more likely to have a 100% repayment plan.
Second, ask yourself whether you have any of the special situations that Chapter 13 is designed specifically to handle: tax debt, foreclosure or fraud.
Another factor to consider is the relative effect on your credit rating. Both debt settlement and Chapter 13 will do a job on your credit rating. In my experience, I have seen client’s credit ratings bounce back about a year and a half after completing a debt settlement plan. In Chapter 13, you cannot get any credit for the duration of the plan, usually 5 years. When you are out of the plan, it shouldn’t take more than a year before your credit rating bounces back to a reasonable level. This one tips in favor of debt settlement.
In a Chapter 13, you have Court involvement, whereas in a debt settlement program you do not. This means that 1) the Court will decide what you must pay each month; 2) the Court will be in your affairs for the next 3-5 years; 3) you may have to justify what you spend your money on each month; and 4) your bankruptcy becomes public record.
In a Chapter 13, you have Court protection, whereas in a debt settlement program you do not. In a 13, the Court forces a payment plan on your creditors, which they must accept once your plan is confirmed. In a debt settlement plan, the creditors continue their debt collection efforts and you may be sued by any number of your creditors. This is why it is critical to shorten the time frame of a debt settlement plan to no more than 24 months. In my experience, if the debt settlement can be done within 24 months by a qualified negotiator, debt settlement works very well for many clients. On the other hand if you try to repay your creditors in a debt settlement plan that is of the 3-5 year variety, you will likely be sued by a number of creditors at once, and you will be forced into bankruptcy despite your efforts.
Tax consequences are also something to consider. I have written an article about that on this site. I recommend that you read it and visit with a CPA to confirm tax consequences of your actions.
As you can see, there are a number of factors to consider when comparing debt settlement to bankruptcy. Please feel free to contact me if you would like a consultation to help review the relative pros and cons in your specific case. It is often said that “a wise man gathers much counsel” and it could not be truer when dealing with your financial future. Visit your local bankruptcy attorney and don’t be afraid to get a number of opinions before you make your choice.
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