What’s Better — Debt Settlement or Bankruptcy?

There are fewer worse feelings than knowing you’re deep in debt. This will not only mean financial problems, the stress related to it can cause physical issues up to and including heart disease. Yes, heart disease.

The best answer to debt is to pay it off. Of course, you may not be able to do this. You could have lost your job, suffered a serious illness or had some other financial emergency that’s left you living from payday to payday. Or maybe you just made a lot of bad financial decisions. But whatever the case, you’re wondering if you should declare bankruptcy.

A fresh start

There is no question but that a chapter 7 bankruptcy would mean a fresh start – assuming most of your debt is unsecured debts like credit card debts and personal lines of credit. They would be discharged in the bankruptcy so you’d no longer be responsible for them. Another advantage of a chapter 7 bankruptcy is that your wages would be exempt– except for money earned through an inheritance. Finally, it’s usually possible to get through a bankruptcy in three to six months for an even quicker fresh start.

The downsides of a chapter 7 bankruptcy

It’s a different story if the majority of your debt is secured debts such as a mortgage, automobile loans, and student loan debts. None of these can be discharged by a Chapter 7 bankruptcy.

A second downside is that you could have property seized and sold by the bankruptcy trustee to satisfy some of your debts. While you’d be allowed to keep your primary vehicle, you could lose a motorcycle, a boat, a camping trailer and other non-exempt property.

The worst downside is what a bankruptcy will do to your credit, which is trash it. Your credit score will plummet. It will take you several years after the bankruptcy to get new credit, and it will have a very high-interest rate. Your auto insurance premiums will increase. Having a bankruptcy on your credit reports will impact your credit for quite some time. This is because the public record of a chapter 7 bankruptcy will stay on your credit reports for 10 years. You could even lose out on a good job when the prospective employer sees you’ve had a bankruptcy. It’s that serious.

The advantages of debt settlement

Debt settlement will not discharge your unsecured debts as will a chapter 7 bankruptcy, but it can get them reduced substantially. In fact, a good debt settlement firm can often get debts settled for 50% or even 40% of their balances. This means you could end up paying as little as $800 on a $1600 credit card debt.

The second pro of debt settlement is that you’ll have a plan with fixed payments each month. You’ll know in advance how many months it will be before you’re debt-free. You’ll also know how much debt settlement will cost as most reputable debt settlement firms charge a percentage of the amount of debt it’s settling for you. This generally ranges from 15% to 25%. However, most settlement firms don’t collect their fees until they’ve settled all of your debts. This amounts to a 100% satisfaction guarantee since you could drop out of your program at any time, and without paying a cent.

The negatives of debt settlement

Debt settlement will affect your credit score but not as severely as a bankruptcy. Many experts think it will drop your score by around 80 points. While debt settlement will not trash your credit history, it will affect it. When you apply for credit in the future, the lenders will see that you had settled your debts instead of paying them off in full. This could also mean you’ll be charged higher interest rates. If the lenders forgive some of your debts through settlement, this will be reported to the IRS as income, and you will be required to pay tax on it.

In conclusion

The best choice between these two options for most people is debt settlement. It will have less of an impact on your credit than a bankruptcy. You can recover faster from debt settlement, and you’ll be doing a more honorable thing – by paying back part of your unsecured debts.