In Bankruptcy Information

drowning-in-debt-300x300Maybe you’ve heard the commercials on talk radio. “Did you know that you have the right to settle your debts for cents on the dollar?” That’s the teaser to get your attention. Then the ad goes on to talk about whatever debt settlement company is sponsoring it and how they can contact your creditors and for a small fee work out a repayment plan so that you don’t have to file bankruptcy or ruin your credit.

There are so many fallacies in those ads that it’s hard to know where to begin. First, you don’t have a right to settle your debts for anything less than what you owe. You have the right to make an offer but the creditor has the right to reject it.

Secondly, the small fee. Debt resolution companies typically require you to pay about 10% to 15% of the payments you make to the creditor to them. So unless they reduce what you owe by at least that amount, you’re paying the same, even if the creditor receives less. Think of the debt settlement company as the middleman who always gets his cut.

Thirdly, the overall costs. How much does that 10%-15% add up to over the course of your debt settlement? For a typical Chapter 7 bankruptcy the legal fees and court costs are usually in the $1,500 to $2,000 range. Can you settle your debts and pay the debt settlement company for that?

Fourthly, how long is debt settlement going to take? The typical Chapter 7 is over and done in about four months. It might take the debt settlement company that long just to negotiate deals with all your creditors. Then you have to start paying.

Fifthly, debt settlement companies say you won’t ruin your credit using them like you will with bankruptcy. True, your credit will take a hit if you file bankruptcy. But here’s a nasty little truth. The creditors won’t deal with a debt settlement company or you or anyone else unless you’re behind. As long as you’re current on your monthly payments, it’s your problem, not theirs. The only way to make it their problem so they have to address it is to stop making payments and become delinquent. Usually that means 90 days late at least. That’s going to ding your credit and in the meantime you get to deal with collection calls.

Finally, there are tax implications to debt settlement that don’t exist in bankruptcy. If a debt is forgiven in part (which is what happens with debt settlement) the forgiven portion is treated as income to the debtor. Suppose you settle $50,000 worth of debt for fifty cents on the dollar. In other words, you pay $25,000 and the creditor releases you from (forgives) the remaining $25,000. The creditor will most likely send you a 1099-C form next year reporting the forgiven $25,000 as income to you and you’ll be taxed on it! Whoa! Better add that to the cost of debt settlement. On the other hand, debt discharged in bankruptcy is not income under the Internal Revenue Code.

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