Debt settlement is often presented as an alternative to bankruptcy, so it’s important to understand how each one of these works. When you’re presented with these two options for dealing with your debt, your future may depend on making the right choice.
How Debt Settlement Works
To settle your debts, you must typically let your accounts become past due so the creditors have a reason to settle the accounts. Sometimes the accounts must even go on to a third-party debt collector before you can negotiate a settlement. This means your accounts have become seriously delinquent and your credit has probably been affected.
Before you can settle an account, you probably have to save up money to make a settlement payment. You’ll typically need between 40% and 60% of the amount of debt for the settlement payment. Creditors most likely want this money in full, so then you would need to have it on hand before you could make the settlement payment.
Ideally, you’ll be done settling all your accounts within two years. If it will take more time than that, you should probably consider filing bankruptcy.
Two Type of Bankruptcy
There are two types of bankruptcy for individuals – Chapter 7 and Chapter 13. Chapter 7 bankruptcy is sometimes known as discharge bankruptcy because most unsecured debts are discharged. To qualify for Chapter 7 bankruptcy, first your current monthly income (as defined in chapter 7 of title 11 of the United States Code) must be below the median income in your state. You might also have to give up some of your assets if they’re not exempt by your state’s bankruptcy law.
If you don’t qualify for Chapter 7 bankruptcy, then your other bankruptcy option is Chapter 13 bankruptcy. Through Chapter 13 bankruptcy you repay some or all of your unsecured debts on a three to five year repayment plan which must first be approved by the court.
Bankruptcy vs. Debt Settlement
Of the three options – Chapter 7 bankruptcy, Chapter 13 bankruptcy, and debt settlement, Chapter 7 bankruptcy is probably the best choice if you qualify. You’ll be rid of most of your unsecured debts in probably less than a year and you can then focus on rebuilding your credit after that point.
Debt settlement is probably the next best choice if you can settle all your debts within two years or less. However, if you think it will take more than two years to settle your debts, then you may want to consider Chapter 13 bankruptcy.
Chapter 13 bankruptcy does have a possible advantage over debt settlement. After you file bankruptcy, the bankruptcy court mandates that your creditors and collectors stop calling you and sending letters. If you go the debt settlement route, you’ll probably keep getting those calls and letters and you may want to come up with a strategy to avoid them.
However, bankruptcy is an action that will stay with you for the rest of your life. While a bankruptcy filing could stay on your credit report for up to 10 years, it’s on record with the bankruptcy court forever. Debt settlement on the other hand, will go away after seven years at the most.
There are pros and cons to each option, so you have to weigh them carefully to decide what option you should choose.