Bankruptcy and debt relief have some similarities; both options have guided programs to help you get out of debt. Bankruptcy is a legal path where you file in court and work with a trustee to discharge or pay back some debts. Debt relief includes various programs or plans to get you out of debt without declaring bankruptcy.
Debt relief programs are not a legal end to creditor harassment. That is only a legal option during bankruptcy once your case is approved. Creditors must stop harassing you once you file for bankruptcy, but they can still call and ask for their payments during a debt relief program. If a creditor or credit card company is offering a debt relief program, you should be wary. They are not working in your best interests and are only interested in their own debt settlement. Bankruptcy can have its advantages because your bankruptcy attorney and bankruptcy trustee are on your side and want to help you find lasting debt relief. It can be helpful to have these advocates as neutral, third-party resources guiding you to a fresh start. Creditors might say only specific debt programs will work for your debt, but this is not true, there might be multiple options available to you, including bankruptcy.
Debt relief programs tend to focus on one creditor or a small part of your debt. This may not be helpful if you have numerous credit cards or medical debt from various places. Through the U.S. Bankruptcy Code, you have the option to:
• Discharge multiple debts in Chapter 7 bankruptcy (but not certain debt like student loans or child support)
• Create an effective repayment plan for all your debt in Chapter 13 bankruptcy
Your credit score lowers every time you cannot pay debts each month. While having some debt is useful to build your credit, not paying it back each month is risky. Month after month of unpaid credit card debt will lower your score over time, whereas declaring bankruptcy will lower your score right away. Through bankruptcy, however, more of your debt can go away, which can lead to improvements in your credit score over time.
Common Debt Relief Plans
There are DIY planning options and companies or professionals who work to get you out of debt. Credit counseling courses can help you understand your debt and get you back on your feet in some cases. If your debt is becoming too high to manage, you may need to consider bankruptcy or one of these debt relief options. Some creditors will accept less money than you owe if you offer a large lump sum instead. If you owe $10,000 in debt, the company knows it will take them years to see that money when you are in debt. They may like that idea since they will gather interest every month. But in some cases, you could offer a lump sum one-time payment so the company gets their money faster.
You need to consider:
• Will the creditor negotiate on the sum? (They are not legally required to negotiate.)
• Will the creditor cancel the debt in full once you make the payment?
• Do you have enough money to cover this payment and monthly expenses?
• Will a lump sum put your property or assets at risk if you go bankrupt later on? (Lump sum payments can turn your unsecured debt into secured debt.)
• What will you do if another creditor pursues a debt lawsuit? Only filing for bankruptcy can stop a debt lawsuit.
• Can you pay extra taxes on the lump sum payment? The payment will go to the IRS as income, and you may be taxed on it.
Debt Consolidation Loans
A debt consolidation loan will pay off all your creditors at once to stop interest and harassment, and you will just have one payment going forward. This can help overwhelmed people who feel like they cannot keep their creditors and debt straight. A loan to pay off debts can seem like a no-brainer, but there are consequences you should consider:
• Risking your assets and property if they are used as collateral for the loan. Missing a payment could result in your home or car being seized and sold.
• A debt lawsuit from the loan company if you cannot pay. This means losing your home, car, assets, or anything else used as collateral and paying attorney’s fees.
• Affording the debt consolidation loan payment if you could not afford minimum payments on your original debt. Often people just become deeper in debt after seeking a debt consolidation loan.
• High-interest rates put you deeper in debt and never help you out of the financial hole you are in.
Consolidating debt with a loan can help you focus on one bill rather than many. However, it does not eliminate debt, and often people find themselves falling deeper into debt through the loan.
Pros of debt settlement companies
• You don’t have to spend time consolidating or negotiating
• Your credit counselor can educate you on improving personal finance
• Paying back a large amount of debt can feel more achievable with support
• They can handle calls or other harassment from debt collectors
Cons of debt settlement companies:
• Some of these companies are scams and should be avoided and reported
• The legit companies may be expensive and require upfront fees and monthly payments for their services
• Creditors might refuse to work with the company or refuse to agree to a debt settlement plan
• Companies cannot stop wage garnishment
• Debt like medical bills and credit cards are not dismissed
• Your credit report will still be affected if you cannot make monthly payments
• Creditors can change their mind and sue you at any time
• It can extend the time you spend in debt
A debt settlement program could be the right step for you if your debt is not very large or you have a steady income. In many cases, filing a bankruptcy case is the fastest way to bring down your total debt. Chapter 13 bankruptcy requires a repayment plan, so it may not be the right type of bankruptcy if you do not have a steady income. It can help people who want to stop creditor harassment and need more time to pay down their debt. Chapter 7 bankruptcy will dismiss unsecured debts, and you do not need to pay them back. It also requires creditors to follow bankruptcy laws, helps control asset repossession, and can rebuild creditworthiness as you make new payments on time. Many people think hiring a bankruptcy lawyer will increase their debt. While you must pay filing fees and attorney’s fees (from $500 to $5,000 on average), it can be cost-effective in the long run as your debts are fully discharged faster.
Debt Settlement
Debt settlement refers to an agreement between a borrower and a creditor to reduce the amount of debt owed. The settlements are for unsecured debt like credit cards or personal loans, and usually, the negotiating is done by a third-party debt-settlement company. While paying less than you owe sounds great in theory, before debt settlement companies negotiate your balances they usually recommend that you stop paying your bills for a number of months to improve your chances of settling. During this time, you save up money for a lump-sum payment, all while late fees and interest pile up and your credit takes a major hit. Once some time has passed, the debt settlement company will get in touch and negotiate a reduced payment. The premise is that getting paid something is better than nothing; hence, some creditors will settle. If a creditor agrees to a settlement, the debt settlement company pays your reduced balance from the account you’ve been putting money into. The company can only charge a fee after the debt is settled. While you can hire a debt settlement company to negotiate on your behalf, you can also attempt to work out a debt settlement agreement on your own by contacting your creditors. Even better, if you get in touch with creditors before you fall behind; you may qualify for a hardship program that can help you better manage your payments.
Pros and Cons of Debt Settlement
Pros
• Reputable debt settlement companies may work out decent deals: If you choose good companies that have industry relationships that may help you get a strong settlement offer.
• You can avoid the legal process of bankruptcy: Because a debt settlement is a private negotiation (unlike bankruptcy, which is public record), it’s not something that will come up in job interviews or other situations where your background might be checked.
• Debt settlement is slightly less damaging to your credit than bankruptcy: Though debt settlement can cause your credit score to take a massive hit during the months that you stop paying your bills, once your debt is settled, it will remain on your credit report for seven years shorter than the 10 years for Chapter 7 bankruptcy.
Cons
• Debt settlement isn’t a quick fix: Saving up enough for your lump-sum payments to creditors can take a few years, so this isn’t always a fast path to becoming debt-free.
• You may have to be delinquent before settling: Instead of making your payments, debt settlement companies have you put money into savings that can be used for a payment later on. In the meantime, your accounts will be hit with late payment fees, your credit score will plummet as the length of your delinquency increases, and you could be hounded with stressful collection calls.
• Debt settlement companies charge fees for something you could do on your own: On top of the amount you’ll still owe your creditors, the debt settlement company will take a fee, thus reducing the amount that you’ll actually save.
• The amount of forgiven debt is considered taxable income: Yes, you’ll have to pay taxes on the amount you saved from the debt reduction. If you owed $10,000 and your creditor reduced the bill to $6,000, you’ll have to pay income taxes on $4,000.
• You could be sued for delinquent payments: Your creditors could sue you if you for your debts before a settlement is reached, or if you stop making payments as part of your debt settlement program.
Why People Choose Between Debt Relief and Bankruptcy
When a person can’t pay their debts, creditors can become extremely demanding in their attempts to collect debts. In some cases, debt collectors may harass individuals for payment of debts. Of course, if you don’t have enough income to make all of your monthly payments then what the debt collector that is calling you may suggest, your financial situation may simply make a payment plan to get back on track impossible. Some debt collectors and creditors may push you toward a specific debt relief option. Keep in mind, though, that their recommended debt relief option may not be in your best interest (especially if it deals with only a small part of your total debt), but it could be in the best interest of the creditor. Before you decide to use any debt relief program, you need to carefully review all of your options to get out of debt. Some debt settlement programs could cause you to get into additional debt problems if you are not careful. You should only make a decision about how to get out of debt after weighing the pros and cons of each debt relief option. Even though some people consider bankruptcy more of a last resort, you should not think of it that way. Ways that filing Chapter 7 may be the best debt relief option for you include:
• Usually takes less than 6 months. Chapter 7 can eliminate most of your debts within four to six months without any payments to the creditors.
• Creditors must obey bankruptcy laws. The creditor can’t continue collection efforts after you file your Chapter 7 petition without court approval. This means all the phone calls have to stop!
• Stop collections and harassment. Creditors are not permitted to collect discharged debts. A creditor may face severe penalties for violating the discharge order.
• Stops wage garnishment. A Chapter 7 bankruptcy case stops wage garnishment, debt collection lawsuits, and other forms of debt collection.
• Erases deficiency judgments. If you choose to surrender your car or house because you can’t afford the payments, a creditor can’t obtain a deficiency judgment. (If you already have a deficiency judgment against you, the Chapter 7 case discharges the debt.)
• Doesn’t have to be expensive. Your costs for filing a Chapter 7 case may be very low if you’re eligible to use up solve free bankruptcy filing tool and file bankruptcy without a lawyer.
A majority of unsecured debts are eligible for a discharge under Chapter 7. Examples of unsecured debts that you can discharge in a Chapter 7 case include:
• Credit card debts
• Personal loans
• Medical bills and expenses
• Personal judgments
• Some old income tax debt
• Old utility, rent, and lease payments
However, some unsecured debts are not eligible for a discharge. Most income taxes are not dischargeable. You can only discharge income taxes that meet very specific requirements. In addition, most student loans are not eligible for a discharge unless the debtor qualifies for a hardship discharge of the student loans. Also, alimony and child support are not dischargeable. You can’t get out of paying your domestic support payments by filing a Chapter 7 bankruptcy case.
Debt Consolidation
Proponents of debt consolidation often promote this strategy as a simple way to save money and protect your credit rating. When you consolidate your debts, you reorganize multiple debt payments into one payment. You can choose to consolidate debt through a secured loan or an unsecured loan.
Pros of Debt Consolidation
• Protect your reputation and credit rating. Unlike bankruptcy, debt consolidation is not a matter of public record. Anyone who looks hard enough will find out about your bankruptcy. Bankruptcy records are viewable through an electronic subscription service called PACER or at any federal bankruptcy courthouse. Although a debt consolidation loan might show up on your credit report, it does not typically lower a credit score like a bankruptcy filing does.
• Maintain your access to credit. Unless prohibited by the debt consolidation agreement, you can keep your credit cards. This might be helpful should an emergency arise. However, if you already owe a significant amount of money or are in default, you might not be able to use your credit cards or be approved for additional credit. Also, continued credit card use might defeat the purpose of debt consolidation.
• Simplify your debt management. When you consolidate your debt, you no longer have to keep up with multiple payments, at different interest rates, to various creditors. Instead, you make one convenient payment.
• Lower interest rate and monthly payment. If you consolidate your debts, you might be able to obtain a more manageable monthly payment, with a lower interest rate. As a result, you will have more cash available each month to meet your high priority needs.
Cons of Debt Consolidation
• You could lose your property. If you use property such as your home or vehicle as collateral for the debt consolidation loan, you could lose that property if you default on the loan payments.
• Also, if a lender gives you a debt consolidation loan, there might be a cross-collateralization clause that allows that lender to take other property it has financed if you default on the debt consolidation loan. For example, let’s say that you have a car loan through your credit union and then the credit union gives you a debt consolidation loan. Under the cross-collateralization clause, if you default on the debt consolidation loan, the credit union could repossess your car—even if the car payments are current.
• Beware of hidden costs. Although lower interest rates and monthly payments are appealing, a debt consolidation loan could end up costing you more money. Often, debt consolidation loans help you achieve a lower monthly payment and interest rate in exchange for extending the repayment period. If you stay in debt longer, you might end up paying more over the long term.
• Negative tax consequences. Depending on your financial condition, any money you save from debt relief services such as debt consolidation may be considered income by the IRS, which means you pay taxes on it. Credit card companies and other creditors may report settled debt to the IRS, which the IRS considers income.
Free Initial Consultation with Lawyer
It’s not a matter of if, it’s a matter of when. Legal problems come to everyone. Whether it’s your son who gets in a car wreck, your uncle who loses his job and needs to file for bankruptcy, your sister’s brother who’s getting divorced, or a grandparent that passes away without a will -all of us have legal issues and questions that arise. So when you have a law question, call Ascent Law for your free consultation (801) 676-5506. We want to help you!
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States
Telephone: (801) 676-5506
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