Debt Settlement and Debt Consolidation versus Bankruptcy

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Debt settlement is a negotiation process whereby a consumer seeks to settle debts away for an amount less than what is owed.  This process generally involves the offer of a lump-sum amount to the creditor to settle away the debt.  The consumer can either negotiate directly with the creditor or using a debt settlement company.

If a debt settlement company is used, it will generally require the consumer to make monthly payments until the company’s fee has first been paid and then continue making monthly payments until the targeted lump-sum amount for settlement has been accumulated.  The debt settlement company then makes the offer to the creditor.  If the offer is accepted, the debt is settled. If the offer is refused, more negotiation takes place until either a settlement is reached or the creditor simply refuses to negotiate.  If the debt is settled and if the amount that was forgiven is more than $600 total, the consumer will receive a 1099-C form at the end of the year for “Cancellation of Debt,” which tax authorities will consider to be “ordinary income” for tax purposes. The entire process outlined above would then be repeated for each debt the consumer has.  If a consumer has several debts (e.g., credit cards) it could take months or years and thousands of dollars to settle away everything.

Generally, debt settlement will only work if you stop making payments on your debts, otherwise there is no incentive for the creditor to negotiate.  When you stop making payments your credit score is going to take a major hit.

Debt consolidation is a process whereby a consumer pays off all his or her debts with a consolidation loan and then just makes one monthly payment to the consolidation lender.  The idea is to get a lower monthly payment to the consolidation lender than the other creditor payments were combined.

Debt consolidation companies often charge high interest rates for the privilege of using their service.  Additionally, it could take several months or years and thousands of dollars to pay off the consolidation loan.  Further, if the consumer has a large amount of debt and has had delinquent payments he or she might not even qualify for a consolidation loan.  Many lenders are also hesitant to offer a consolidation loan if the consumer has not filed for bankruptcy because he or she could get rid of that debt in a bankruptcy.

If you file for chapter 7 bankruptcy, the discharge of the debt usually comes within 3-4 months after your petition is filed.  Also, you won’t receive a 1099-C form at the end of the year because debts discharged in bankruptcy are not considered “ordinary income.”  If your credit score is already damaged, filing for bankruptcy will often improve your score much more quickly than with debt settlement or debt consolidation.

If you’re not eligible for chapter 7 bankruptcy you could try a chapter 13, which is a repayment plan.  In chapter 13 bankruptcy, unsecured credits (e.g., medical bills, credit cards, etc.) often end up not receiving much and get discharged at the end of the plan, which runs between three and five years.

If you are considering debt settlement or debt consolidation you should seriously take a look at bankruptcy instead. If you could save thousands of dollars, could repair your credit score more quickly, and could be finished a lot sooner than with debt settlement or debt consolidation, wouldn’t you want to do that?

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Jeffrey L. Wagoner


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