Considering Debt Settlement? Perhaps Bankruptcy Is Cheaper And More Efficient

11 Jul Considering Debt Settlement? Perhaps Bankruptcy Is Cheaper And More Efficient

Often people come to see me who have been working with a debt settlement company but are unable to manage the payments to the debt settlement company or get discouraged with the whole process. How can bankruptcy be better?

To be clear, a debt settlement company is an entity that will take your money in monthly installments and builds up a sum that will be used to settle your debts. Once that sum is built up, the debt settlement company will then make a lump sum offer to your creditors for payment in full satisfaction of their claim. For this “service,” the debt settlement company charges a fee which is typically a percentage of the total debt.

For example, if you have three credit cards totaling $25,000.00 in unsecured debt, the debt settlement company will say that they can settle the accounts for $15,000.00 (approximately 60%) and will charge a fee of $3,750.00 which is 15% of the total debt. Thus, your total payment to settle $25,000.00 in credit card debt is $18,750.00 ($15,000 paid to creditors and the fee of $3,750.00). In order to have this money available to make the “settlement offer,” you pay inapproximately $800 a month for 24 months (of course, this may vary among companies). Generally, the debt settlement companies want your accounts to go into “charge off” status.

So what happens if one of your creditors with whom you wish to settlerefuses the settlement? You are still obligated on the debt. Just because a debt settlement company says that they can settle your debts, that does not mean that the creditor will actually accept the offer. So, in the above example, if one of the creditors does not settle, you still must pay that creditor or seek some other alternative.

Another issue concerns your credit rating while you are paying the debt settlement company each month building up your “settlement funds.” Your credit rating or score goes down the tubes. My colleague, Kurt O’Keefe, has just written a nice piece on that very topic. See The Secret toNew Credit After Bankruptcy. Your score is dependent on your paying your bills on time. If you do not, such as through payinga debt settlement company, your score goes down. So, assuming that you do settle with your creditors, your credit score is still trashed.

So how can bankruptcy be better? First, the fees involved are typically much, much cheaper. For example, in my area, a routine chapter 7 can typically be accomplished for $2,500.00 to $3,000.00 inclusive of the costs. In a typical, “no-asset” chapter 7 case, you do not pay anything to your creditors so that you are not obligated to pay $15,000.00 towards your credit card debt (this scenario assumes the case is a “no asset” case). That money is saved.

While it is true that bankruptcy does not help your credit, once it is done, you can start working toward building your credit back. Unlike the above scenario with the debt settlement company, as soon as your bankruptcy case is over, you can start toward rehabilitating your credit. Perhaps in your bankruptcy case, you reaffirmed a mortgage or automobile loan–those creditors will report that you are making your payments on time (assuming that you do). This will start you on the road to credit rehabilitation.

I rarely recall seeing a debt settlement company that could offer a better “deal” than bankruptcy. The bankruptcy fees are cheaper and the total cost is generally must less. Plus, you can start rehabilitating your credit so much sooner with a bankruptcy filing than working through a debt settlement.

Photo credit: Project 404 (via Flickr).

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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.
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