Debt Settlement vs Bankruptcy

You may have heard commercials from debt settlement companies promising to settle debts for pennies on the dollar or for low monthly payments. You should be skeptical about these claims. Many national debt settlement companies do more harm than good.

In most cases, you are better off working with a local attorney. An attorney will offer several solutions and not push you into debt settlement. An attorney has an ethical obligation to serve your best interests. National debt settlement companies do not. They will push you into a debt settlement plan even if other solutions would be a better fit.

The majority of national debt settlement companies simply do not deliver results. According to a recent survey by the National Consumer Law Center, only 1.4% of the people entering debt settlement program successfully complete their program and many companies are routinely under investigation for fraudulent business practices.

Debt Settlement Does Not Save Your Credit

There are legitimate reasons to pursue debt settlement, however, debt settlement will not allow you to preserve a good credit score. A settled debt is reported to the credit agencies and it has a substantial negative impact on your credit. Although bankruptcy hurts your credit as well, it does not require you to part with thousands of dollars. The impact of a debt settlement is just as harmful as a chapter 7 bankruptcy to your credit. The debt settlement companies will not tell you this.

National Debt Settlement Companies have an Inherent Conflict of Interest.

Commissioned sales people often lead debt settlement firms. They have a simple goal in mind: high volume sells. They are not required to look out for your best interests. They are paid to sell you one program – debt settlement. Because they only sell one thing they are biased toward that one program. One of their favorite tactics is to provide misleading information about bankruptcy such as that debt settlement is much better on your credit than bankruptcy. The truth is, debt settlement is not better, and it is expensive.

Up to 25% of every month’s payment goes toward a “management” fee.

National Debt Settlement Companies DO NOT Stop Lawsuits from Creditors

Your monthly payments do not go to your creditors. Instead, they go into a pool of funds managed by the debt settlement company. Each month this pool grows until there is enough funds to make a reasonable offer to one of your creditors. The principle amount of your debts will continue to grow each month until they are settled. As the collection cycle continues, you may be served with a lawsuit and have your wages garnished. Debt settlement firms cannot prevent legal action.

How much of a discount do creditors offer?

How much of a discount you receive depends on several factors:

  • Age of the debt: As a general rule, the older the debt, the better the percentage discount you can expect. This is especially true for accounts that have been sold to a third party. This is known as debt factoring. The firm who purchases the debt will pay a percentage of the collectible balance for the right to collect the entire balance. For example, if you have a balance of $4000, the debt purchaser may pay $1000 to the original creditor for the right to collect the full $4000. Many lenders (banks) sell debts because they are not in the debt collection business.
  • Nature of hardship: If you have an extraordinary hardship (lost job, death in family, fire, disability) you often get a better discount. You must be able to substantiate your financial situation with verifiable documentation such as recent tax returns.
  • The creditor: Some are more difficult to work with than others. Discover, for example, will rarely settle for less than 40% off. Certain other creditors will offer settlements for as little as 15% of the amount owed.
  • Time of the year: You often can get a better deal at the end of quarter or month, especially when working with a collection agency because they are judged by the total amount they collect per quarter. If they are nearing a deadline they more likely to take offer a better deal.

Note some creditors (e.g. medical providers) will not settle for less than the full balance or allow a revised monthly payment plan. If your creditor offers a reduced balance to settle your debt, you must be able to pay off the settled balance within 60 to 90 days.

When Debt Settlement is a Good Option

Can you possibly pay off your debt in two to three years and still maintain a healthy life style? If the answer is no, debt settlement is probably not worth it from a financial and strategic perspective. Keeping that basic rule of thumb in mind, good settlement candidates typically have the following profile:

  • A relatively small number of creditors
  • Reasonable debt load given assets and income
  • Ability to pay-off the settled balance within 90 days
  • Significant assets that would not be protected under bankruptcy

If debt settlement is for you, go with a legal professional not a $12 an hour telemarketer. Working with an attorney is advantageous for the following reasons:

  • Lack of an agenda: A lawyer will not have a financial stake in which option is best for you.
  • Extensive real-world experience with many of the major creditors and local collection firms. An attorney should understand debt settlement guidelines, which factors can help get a bigger settlement, and when many of the creditors are more likely to offer greater discounts. In short, a lawyer will accumulate knowledge about the major creditors. Debt settlement companies, on the other hand, are staffed with underpaid personnel where employee turnover is high. In some cases, the debtors only other option is to file bankruptcy. If this is the case, an attorney will advise the creditor of this which may help understand the creditor understand the depth of the debtor’s hardship.

While the objective of debt settlement companies is to sell, an attorney’s objection is to help and advice. You should never enter into a debt settlement agreement without consulting with a bankruptcy attorney.