Alternatives to Bankruptcy: Debt Settlement-Is It Feasible?

12 Oct Alternatives to Bankruptcy: Debt Settlement-Is It Feasible?

As I stated in my prior post, another way that you can deal with your debts is to attempt to settle your debts with your creditors. You can do this yourself or through any of numerous “debt settlement” agencies that typically populate television and the internet. Is a “debt settlement” a feasible alternative to bankruptcy?

We have written about debt settlement agencies quite a bit on this blog. Generally, we are not in favor of debt settlement agencies or debt settlement as a realistic means of dealing with your debts like Douglas Jacobs and Adrian Lapas stated. To more fully assess our opposition to debt settlement agencies; it is first appropriate to discuss what exactly is “debt settlement” and some of the problems facing the industry.

Typically, a “debt settlement” agency will promise to settle your debts for much less than what you owe. So, how do they do this? Generally, the debt settlement agency will total all of your unsecured debts like credit cards. They will then require that you pay money into their office every month and hold that money until enough is paid in so that the agency can start negotiating with creditors. In the meantime, the debt settlement agency will deduct their fees each month out of your monthly payments. Typically, the fee charged is 15% of the outstanding debt. Often, the debt settlement agency will withhold their fees before engaging any negotiations with any creditors.

Assuming that you have paid into the debt settlement agency enough money, the debt settlement agency will then attempt to negotiate with your creditors to settle the debt for less than what is owed in one lump sum. A typical settlement with any one creditor is to pay approximately 50-60% of the debt outstanding. So, if on one credit card you owed $10,000.00, the debt settlement agency would negotiate paying $5,500.00 and the debt will be satisfied. Of course, you will have also paid the debt settlement agency 15% of the outstanding debt which is $1,500.00. Total payment on this one debt is $7,000.00.

If that were you only debt, then perhaps debt settlement is a feasible option. After all, you are getting a discount (not much of one). However, most debtors are in a significant amount of debt—anywhere from $30,000 up to $75,000 (or more!). If your debt settlement agency were to settle all of your debts of $50,000.00 at 50%, you would pay $25,000.00 on the debts plus you would pay $7,500.00 in fees for a total of $32,500.00.

Additionally, while you are paying enough money into the debt settlement agency to be able to settle with your creditors, your creditors are not getting paid. When they are not getting paid, they start reporting to the credit bureaus that you are behind on your payments. Once you are late on your payments, your credit score starts to tank. So, one of the reasons for contemplating a debt settlement agency (at least I’m paying the creditors something—that should help my credit score, right?) turns out not to be so great.

There is another nasty, potential surprise, as well. If you settle a debt for less than what is owed, the creditor will most likely submit a Form 1099-C to the IRS on the amount of debt that was canceled or forgiven. Based on this 1099, the IRS may wish to treat the amount of debt cancelled as “income to you” for tax purposes! So, if you have a $10,000.00 debt and pay $5,000.00 and $5,000.00 has been canceled, the IRS may treat that $5,000.00 canceled debt as ”income to you”! This could mean that you are taxed on $5,000.00 more income than you received! Granted, if you file a Form 982 and can demonstrate that you were insolvent at the time the debt was forgiven or canceled, then the debt may not count as income but it is your responsibility to file the form as Kent Anderson stated on this site. This can be a hassle—particularly if you are unaware of this requirement.

And, it should be remembered, that a debt settlement agency is trying to settle with all of your creditors. If one creditor chooses not to “play ball” and settle, then you are still stuck with paying the debt in full or take the consequences of not paying such as a lawsuit by that creditor. If a lawsuit is initiated and judgment obtained, then you may still be subject to all after-judgment procedures such as wage garnishment (if applicable) that a creditor can exert. So, you have just settled with most of your creditors and one is now throwing a monkey wrench into your plans.

So, there is no guarantee that a debt settlement agency will achieve your goals of getting rid of your debt. But, even if the debt settlement agency is able to settle your debts, your credit score will still be in the tank and you are likely to pay a lot of money towards this debt.

In comparison, a bankruptcy lawyer can get your debts discharged (assuming you pass the means test and other issues). Creditors do not get a vote. If you are eligible for a chapter 7 case and, in consultation with a qualified bankruptcy lawyer, you will come out of bankruptcy debt free! With regards to the tax consequences as mentioned above and as Dan Press stated, debts discharged in bankruptcy are not counted as income. While it is true that your credit will take a hit—it is bankruptcy after all, once your bankruptcy case is over, you can work toward building back your credit.

Here is the kicker in the comparison between debt settlement agencies and bankruptcy lawyers, bankruptcy lawyers charge considerably less. For many routine chapter 7 cases, while fees will vary across the country, fees for lawyers generally are no more than $2,500.000 excluding filing fees and credit counseling fees. Compare that to the $7,500.00 that a debt settlement agency may charge on a $50,000.00 debt settlement plan. And, the bankruptcy lawyer can generally tell you with a reasonable degree of certainty that your debts will be discharged.

If you are facing overwhelming debt, consult with a qualified, experience bankruptcy lawyer such as those on this website. We will tell you candidly what your options may be. It doesn’t hurt to find out from a qualified professional about your options.

Related Posts Plugin for WordPress, Blogger...
The following two tabs change content below.

Adrian Lapas, Esq.

I've been practicing bankruptcy law in North Carolina since 1993, and am certified as a specialist in consumer bankruptcy law by the North Carolina State Bar.
No Comments

Sorry, the comment form is closed at this time.