Shouldn’t I do everything possible to deal with my debts prior to filing a bankruptcy? There are so many advertisements out there suggesting that debt settlement companies can help me settle my debts and “avoid” bankruptcy. But can they really? Is this even helpful in the long run? And is it worth spending good money trying to avoid bankruptcy, when either bankruptcy is inevitable or is simply not worth avoiding?
Advertising constantly suggests that debt settlement is easy and effective. The reality, however, is that while debt settlement can be the right course for some, it is not the best alternative for most. Studies have suggested that less than 5% of clients are truly appropriate candidates for “debt settlement.” In most cases, it is neither “easy” nor “effective.”
Of course, the debt settlement companies would disagree and likely suggest it as the best option for you. This is how they make money … and take yours. Most of these companies work with some of your creditors but not all. In addition, as they work out a payment plan, take control of your money, and pay themselves a commission as they do so, they often do nothing that you couldn’t do yourself. However, what you really need is an objective assessment of your situation from someone who does not work for the debt settlement company, one which will lay out the pros and cons between settling your debts and seeking the protection of the bankruptcy laws.
Here are a few factors that will help you determine if debt settlement is right for you:
• Do you have the immediate ability to make a large lump sum payment.
Creditors are generally not willing to settle the amount owed or even lower their interest rate if all you can offer is a monthly payment plan. They will almost all agree to a lower monthly payment if you ask, but the interest still continues accruing on the unpaid balance and the principal amount is not lowered at all. In order to get a discount (of either interest rate or balance owed), you must have funds immediately available in order to settle the debt in one full payment. Lump sum payments is how all debt settlement works regardless of what you hear on TV. Most of these settlement companies simply put aside and save the money you pay them until they have accumulated enough to attempt a lump sum settlement offer with your creditors. If you don’t have this money available or don’t have enough funds available to provide each of your creditors with an acceptable lump sum amount, then a Chapter 7 or a Chapter 13 bankruptcy will likely be a better option.
• Do you have “at-risk” assets.
You need to determine whether you have significant non-exempt assets that would be at risk of losing if you were to file bankruptcy. If you don’t have non-exempt assets, there is less of a reason to consider debt settlement. Either a Chapter 7 or Chapter 13 is likely to be a better option. However, even if you have assets that you may lose in a bankruptcy, a Chapter 13 plan can be an excellent option to both keep that property and force the creditors to stop adding interest and take a discount on what is owed to them. This is especially true if you don’t have the cash available to effectuate a lump sum settlement with your creditors.
In generally, a debt settlement plan normally works best with a person who has some cash available and also has equity in a residence that exceeds the homestead exemption ($75K in Colorado ($105K if over 60 or disabled), has a valuable business, rental property with equity in it or receives money or property from a trust or upcoming inheritance.
• The 2-3 year test.
Can you possibly pay off your debt in 2-3 years and still live comfortably? If the answer is no, debt settlement is probably not worth it from a financial and strategic perspective. This is because you could file bankruptcy and still get your credit back with a year or two after filing. Remember that your credit can rebound quicker than you think and you can qualify for an FHA home loan often within two years from your bankruptcy filing date. On the other hand, a debt settlement has a huge negative impact on your credit. Your credit report will indicate that you settled the debt for less than the full amount and that the creditors took a loss. Your debt settlement will continue to hound you and your credit rating for at least seven (7) years. When you keep that in mind, if you can’t pay off your debt in two or 3 years, it would likely be better financially and for your credit record to simply file bankruptcy.
• Number of creditors and overall debt level.
Despite what the TV and radio ads suggest, the more debt and more creditors you have, the less likely it is that debt settlement is a good option. The debt settlement companies can often only work with some of your creditors. Some will tell you this, others will simply take your money and inform you that they couldn’t work with some of your creditors at a later date. What good is settling some debts while the others continue to harass, sue and attempt to garnish you. A vast majority of those working with debt settlement companies eventually look into filing bankruptcy at a later date (and after making a lot of payments attempting to settle the debt that they eventually bankrupt). The debt settlement companies want people with large debts – that means they make more money. However, in reality, the more debt you have, the more likely they cannot solve your entire problem and a bankruptcy may remain on the horizon.
• Payment plan debt settlements seldom work.
According to the National Consumer Law Center, only 1.4% of the people using a payment plan debt settlement program successfully complete them. The remainder simply end up dealing with the same debts later unless they eventually file bankruptcy. Only bankruptcy can deal with everyone at once and can be done and over with quickly.
• Debt Settlement is much cheaper than filing bankruptcy.
This is simply wrong. Most Chapter 7 bankruptcies with full attorney representation run between $1,000 and $2,000. Since most debt settlement companies take a commission or charge a fee of 10% or more of the debt they attempt to service, anyone with more than $10,000 in debt will likely pay as much for their debt settlement services as they would have to file bankruptcy. And then, they often find themselves having to file bankruptcy at a later date anyway.
• Chapter 13 can do everything that debt settlement can do.
While a Chapter 7 bankruptcy may be the best way to go, in some case you will be required to file a Chapter 13 payment plan case. But even such a plan is typically more advantageous that most debt settlement plans. Only an experienced attorney can demonstrate how a Chapter 7 or a Chapter 13 payment plan can be more advantageous, less expensive and less stressful than a debt settlement plan. Talk to an experienced attorney (one who does both Chapter 7 and Chapter 13 cases) before getting hooked by a debt settlement company’s phone operator.