Debt settlement vs bankruptcy: What’s the right choice for you?

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When you’re in need of serious help getting your credit back on
track, there are two debt relief options that are worth considering.
Both debt settlement and bankruptcy will reduce or eliminate your debt,
but can also negatively impact your credit in the near term. Here’s what
you need to know about both.

What is debt settlement?

Debt settlement allows you to negotiate with creditors to pay off debt on
delinquent, unsecured credit accounts and personal loans for less than
you owe. For example, a person with a $10,000 balance on their credit
card might pay $4,000 to close and “settle” the account and have the
remaining $6,000 forgiven.

Debt settlement is really only a viable
option for people who have reliable income. That’s because you’ll need
to make each payment you agree to with creditors over the course of your
settlement plan, which for some, can last a couple years (learn more
about debt settlement here).

What is bankruptcy?

Bankruptcy
can give you a fresh start or help you re-organize your debts and pay
your creditors less depending upon the type of bankruptcy you file. All
bankruptcy provides court-ordered protection from creditors, but the
type of bankruptcy you file will depend on your personal financial
situation. Chapter 7 allows for your debts to be fully discharged, while
Chapter 13 provides for an organized repayment plan (there’s also
Chapter 11, though it is most often used by businesses). You can learn
more about the differences between the types of bankruptcies here.

Related article: Thinking about bankruptcy? These options may be better.

The pros & cons of bankruptcy

Relief
from your debts under Chapter 7 is fast. It’s usually completed within
90 days of filing for bankruptcy protection. Once your case is
discharged, you can often apply for new credit cards within just a few
months, and you’ll likely qualify for a home loan in two to three years,
and federal student loans after three years. Keep in mind you may be
required to liquidate some of your assets under Chapter 7. This varies
on a state-by-state and case-by-case basis.

And don’t forget that
filing bankruptcy impacts your credit for seven to 10 years and will
delay your short-term financial goals. That can be especially hard for
people who file Chapter 13 and aren’t able to complete their payment
schedule. They end up taking the credit hit of filing bankruptcy and
then, because they miss their payments, lose the benefits of bankruptcy
protection, owing their debts in full again.

Bankruptcy carries a stigma for most people, but it can be a very useful financial tool if your situation warrants it.

“Bankruptcy
is not the nightmare it’s made out to be by a lot of folks, but it does
damage your credit,” Michael Bovee, co-founder of HelloResolve.com,
said. “But the fact is, there’s a time for it. Even if you can do other
things to tackle a mounting debt problem, bankruptcy can prove to be the
right option.”

The pros & cons of debt settlement

This can
be a good debt relief option for people who don’t want to file or don’t
qualify for bankruptcy. Debt settlement is often quick, and plans can
be completed in as little as a couple weeks to a couple years, which is
significantly less time than the payment schedules under Chapter 13
bankruptcy. And if you choose to do your own negotiations or work with a
service that offers reasonable fees, this can be a cost-effective
solution and save you a lot of money.

Like bankruptcy, debt
settlement has a negative impact on your credit because you can’t even
start negotiating with most creditors until you are at least 90 days
past due on your account. There also can be tax implications. You may
owe taxes on the amount of debt your creditors forgive (while there are
no tax implications on debts forgiven or discharged in bankruptcy).

One
of the biggest challenges of opting for debt settlement is that it
doesn’t provide protection against collections or lawsuits the way
bankruptcy does. However, once you complete your settlement payments,
you can start rebuilding your credit right away (though you probably
won’t qualify for the best interest rates since your credit scores have
probably fallen).

How to decide which is right for you

As
you consider debt settlement and bankruptcy, it’s important to take an
honest look at the amount of your debt, your budget and your available
funds/income (here are seven questions to ask yourself to help you decide your best option). Identify short- and long-term financial goals and how your
credit health will impact these.

To assess your qualifications
and options for filing bankruptcy, it’s best to speak with a bankruptcy
attorney. Most offer a free consultation and you’re under no obligation
to file after speaking with them.

If you’d like to consider debt settlement, you can begin by assessing:

  1. Your balances. Some amounts are too small for settlement.
  2. Your creditors. Each company has its own approach to dealing with delinquent accounts and their policies change periodically.
  3. Your
    cash flow. Do you have the funds to settle all your debts within 18
    months or, ideally, 12 months as this reduces the risk of being sued?
  4. Your budget. Can you pay your settlements on time and still pay your other bills?
  5. Additional
    funds. Are there other sources of funds, e.g., something you can sell,
    loans from family or friends, that you can access?

If debt
settlement is the right option, you’ll work with a debt settlement
company to negotiate on your behalf or you can negotiate directly with
each of your creditors.

This article originally appeared on Resolve and was syndicated by MediaFeed.org.

Featured Image Credit: CarlosDavid.org / iStock.

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