For the purposes of this discussion we will presume that you qualify for bankruptcy, but that a debt settlement may be possible.
A debt settlement typically happens as follows: A third party negotiates a pay-off figure lower than the actual balance in exchange for a closed account or a release. Can an individual settle an account by themselves? Absolutely. However, creditors are more likely to settle with a third party in the business of settling for obvious reasons. A third party will have verified the availability of funds and obtained permission to settle before making the first call. The individual may be “testing the water”, which is a common occurrence. In addition, the individual will tend to continue to negotiate even after a deal has been made. Not surprising, when dealing with your own money. Why settle at 40%, when you can try for 30%?
So, you owe a total of $50,000.00. You can settle this debt at 40% (this is just an example, but numbers can fluctuate between 25% and 50% depending on the debt). So 40% of the debt is Twenty Thousand dollars ($20,000.00). Now ask yourself:
First, are you in a position to pay $20,000.00? Probably not. If you are considering bankruptcy or if you have stopped paying your monthly minimums you probably don’t have Twenty Thousand dollars to settle a debt. A typical Chapter 7 bankruptcy costs between Two Thousand dollars ($2,000.00) and Twenty Five Hundred dollars ($2,500.00). Note these fees may vary, but your bankruptcy attorney (hopefully myself) will explain the fee before any work is done. So, considering our model, Twenty Thousand dollars ($20,000.00) versus Two Thousand dollars ($2,000.00).
Second, why are you settling instead of filing for bankruptcy? Remember, we are assuming you qualify for bankruptcy. So, the most common answer is “my credit”. Well, your credit is already negatively affected because you have Fifty Thousand dollars ($50,000.00) in credit card debt that you are not paying. In addition, settling your debt will also affect you credit score in a negative way. Will it have as much of an effect as filing for bankruptcy? There are a lot of factors that go into that answer- but consider the following: Are you settling all of your outstanding debt? Will you be able to settle all of your debt at once and in a certain time frame? Some creditors may settle while others will hold out until the debt is purchased by a debt collector. So debt may even “charge off”, which we can address below.
Make no mistake, filing for bankruptcy will have a negative effect on your credit score. However, it is the equivalent of tearing down the fractured structure and rebuilding. Within as little as two (2) years you can rebuild credit into the high 600’s. Perhaps higher with help. So, the next time someone reviews your credit report when applying for a loan they will see that you A) Settled debt and are trying to rebuild credit; or B) filed bankruptcy and are trying to rebuild credit.
If you cannot settle all of your debt at once and have other debt lingering your credit will suffer. Bankruptcy is a 90 day (in most cases) process after which the individual can immediately start rebuilding.
Are you aware of the other costs?
If you are filing for bankruptcy you will not receive a 1099 for your discharged debt.
If you settle your debt you may receive a 1099 for your settled debt.
In other words, if you settle that Fifty Thousand dollars ($50,000.00) for Twenty Thousand dollars ($20,000.00) you may receive a 1099 for Thirty Thousand dollars ($30,000.00). You will have to then report a 1099 on your income tax return for Thirty Thousand dollars ($30,000.00). That can and may result in a tax debt of Ten Thousand dollars ($10,000.00) at the end of the year. Simply, you may pay ANOTHER third of what you saved to the federal government as income tax.
I would say the choice is yours if there was really a choice to make.