Guiding You Through Your Important Legal Needs

Should You Choose Debt Settlement Or Bankruptcy?

Enduring financial problems is a very difficult and stressful situation. People who are in a difficult financial situation want to make the right decision, but, perhaps they are not fully informed of all of their options. As a result, people assume that if they can avoid bankruptcy at all costs, then any other solution will do. One option that people seek in an effort to avoid bankruptcy is debt settlement. This article will briefly discuss some of the differences between going through debt settlement and bankruptcy, and some particular pros and cons associated with the process.

Can debt settlement companies be trusted?

Debt settlement companies bombard the public with television and radio advertisements, stating things like: Don’t even let the word “bankruptcy” enter your mind. Unknown to unsuspecting consumers are the many traps and pitfalls of going through debt settlement. They are also unaware of the awful things that some of these companies have done to consumers. In fact, many state governments have prosecuted legal actions against some of these companies for alleged wrongdoings. Well, you’ve heard the saying before, and it applies here: Buyer beware! These companies may be using the inappropriate stigma of bankruptcy to pressure you into making the wrong decision for your situation.

How does the debt settlement process work?

A. Payments

Debt settlement companies typically tell their clients to immediately stop paying their creditors, and instead, send their money directly to them. The payments are usually required to be monthly, and in a substantial amount that may not be affordable long term for the client. If the payments are not affordable for you, you may be asked to unnecessarily liquidate your retirement accounts or borrow money from friends or family. Otherwise, the monthly payments are usually attached to your bank account, so that they can take your payment from you with ease. In fact, we have met with many people who continued to have payments deducted from their bank account even after they canceled their contract.

B. How will debt settlement payments be used?

Many people think that their debt settlement payments are being held in reserve to try and settle your debts. However, the fine print of the debt settlement services contracts often states that all money paid to the company goes toward their fees first.

C. What happens after someone stops making payments to creditors and starts paying a debt settlement company?

1. Harassing phone calls and collection letters

When someone stops making payments to their creditors and begins paying a debt settlement company, their creditors will start the debt collection process. This process typically includes harassing collection phone calls and threatening collection letters. If a person avoids the debt collectors, they may call their place of work, neighbors or family members, in an attempt to collect the debt. Remember, they were probably given some of this information when the credit account was opened. If not, they have ways of finding it.

2. I’ve been sued by my creditors

As the financially distressed person continues to pay the debt settlement company and not their creditors, eventually, many creditors will sue you in court. The legal paperwork could be served by the sheriff, and the stress just continues to build despite the debt settlement company’s representations. One idea of debt settlement is that creditors will be desperate and willing to settle a debt at a lesser amount once they file a lawsuit. However, this is no guarantee. In fact, most creditors know that people cannot afford to pay an attorney to defend the several lawsuits that are being mounted by the creditors. Unless the lawsuits are stopped, they will eventually get a judgment that will be used ultimately to collect or liquidate your property to satisfy the judgment. If they cannot find a property to liquidate for payment, they may subpoena that person for a deposition to ask them under oath where their property is located. If the person does not show up at the deposition, a bench warrant could be issued, and a civil lawsuit could then turn into something much more dangerous.

D. A debt settlement is not a guarantee

The debt settlement company cannot guarantee that the debt collectors will ever settle for any particular amount, though a lump-sum offer is usually made. Often the problem is that a large amount of the money paid to the debt settlement company may have already been used to pay their fees, leaving little money left over to settle your debts. If a debt settlement client is able to settle a debt that may leave them with little to no money to settle the debts of other creditors in time to avoid a judgment being entered.

Are there income tax implications to doing debt settlement?

From our experience, another important piece of information that unsuspecting consumers don’t know is that there may be significant income tax implications associated with debt settlement. If a debt is settled with one of your creditors, there is a very good chance that it may result in the remaining unpaid balance being considered debt forgiveness. A debt that is forgiven may trigger a 1099-C issued from the creditor to the IRS. Now, the part of the debt that was “forgiven” might be considered taxable income for that particular tax reporting year.

For example, if a $15,000.00 debt is settled for $8,000.00, the $7,000.00 that is not paid will likely be considered “forgiveness of debt,” and that individual’s taxable income for that year just increased by $7,000.00. As one can imagine, the more debt that is forgiven, the more an individual’s tax liability could increase. Now, a debt settlement client may have tax problems on top of debt problems. You will need to speak to your tax professional to be fully advised of all tax implications.

How will debt settlement affect my credit report and credit score?

Most individuals are rightly concerned about how their credit score will be impacted by their financial decisions. This should be no different when engaging the services of a debt settlement company. When a debt settlement client stops paying creditors, their credit listings will be reported as delinquent, 30, 60, 90, 120 days late, and then charged off. “Charged-off” is not a good thing, and it usually reflects the fact that the creditor has written off the debt as a loss on their books and sold it to a debt collector who will be much more aggressive with their collection techniques. With these types of credit listings, it may prove nearly impossible for an individual to be granted any credit while engaging in debt settlement and for a certain significant period thereafter. Additionally, with so many delinquent accounts constantly being reported in negative status, there is very little opportunity for the credit score to substantially increase during or even after the process is completed.

Is bankruptcy right for me?

After reading the above information, it is important to know how bankruptcy might compare to those issues. Listed below is a quick comparison of debt settlement to bankruptcy. You will need to contact our lawyers at our office in Pittsburgh, Pennsylvania, for more detailed information or to determine whether bankruptcy is right for your financial situation.

  1. Is bankruptcy cheaper? Bankruptcy is typically cheaper than debt settlement. Oftentimes, an individual can pay for their entire bankruptcy case with just three months’ worth of debt settlement monthly payments. Debt settlement could cost five, 10, 20 times, or more than a typical bankruptcy filing.
  2. Will creditors harass me after I file bankruptcy? As soon as your bankruptcy case is filed, the automatic stay protection of the federal bankruptcy code automatically stops most collection activities against you. No more harassing phone calls or collection letters from credit card companies and debt collectors. Creditors cannot file lawsuits against you while you are in bankruptcy, and once a bankruptcy is completed, creditors are forever enjoined from collecting from that individual altogether. A bankruptcy filing will also stop a foreclosure of your home or repossession of your car, as well as providing other important protections to you and your property.
  3. How long does the bankruptcy process take? Some bankruptcy cases can be over in as little as four months, from start to finish depending on an individual’s situation. Debt settlement, and the implication of that process, often lasts for years. There is usually a better chance at a true “fresh start,” which is the stated purpose, in bankruptcy.
  4. Will all of my debt accounts be handled all at once in bankruptcy? Bankruptcy addresses all of your pre-filing date creditors at the same time, and most debts will be eliminated with the exception of a few nondischargeable debts. Debt settlement will require you to try to juggle all of your creditors with limited funds. Trying to settle debts separately with numerous creditors, all of whom want to be paid before the other creditors, can be daunting, stressful and nauseating.
  5. How does bankruptcy affect my credit report and credit score? Debts included in bankruptcy should be listed as included in bankruptcy on your credit report. Once your bankruptcy case is completed, you should receive offers from creditors that will help you re-establish your credit. Your credit score could increase significantly even in just the first year out of your bankruptcy case if the right decisions are made. Somewhat similar to delinquencies and charge-offs, a bankruptcy will likely be listed on your credit report in the public records section for seven or up to 10 years. However, future creditors should perceive your spending ability in a much better light after your debts are discharged, as opposed to if you are spending a good chunk of your disposable income on a debt settlement payment. Additionally, future creditors know that your ability to file a bankruptcy in the future could be limited for up to eight years.

Disclaimer: This article is an editorial and for general information purposes only. It is not intended to be legal advice and it is not a substitute for being represented by an attorney. In some situations, this information may be specifically related to a certain state or area and may not be the law in the area in which you live. Should you need more information or wish to speak with an attorney, please contact us.