Getting into financial trouble can be overwhelming. Many people shove it under the rug, but that only works for so long. There comes a time when you need to face the music and find the best way out.
In 2016, 794,960 Americans chose to file bankruptcy, according to U.S. Federal courts. Is that the best choice for you, though?
We are going to examine filing for bankruptcy and negotiating a debt settlement. You’ll learn what each route entails along with the eligibility requirements, costs, and pros and cons.
Let’s get started by taking a look at bankruptcy.
In general terms, most of us know bankruptcy means throwing our hands up and waving the white flag to surrender financially.
However, more specifically, it is a legal proceeding for people who have outstanding debts that they can not pay. It can allow you to get a fresh start, but it does come with costs.
The two bankruptcy options individual debtors should know about are chapter 7 and chapter 13.
Chapter seven debt relief
Chapter seven bankruptcy is also known as a “liquidation” bankruptcy. When you file, a three to 6-month process begins in which an appointed chapter seven trustee manages your case. They determine if you have any eligible assets they can sell to repay your creditors.
However, in many cases, debtors don’t have any eligible assets. The definition of eligible assets in chapter seven cases varies by state. For example, some have exemptions for your home or car up to a set amount.
Once the trustee sells your nonexempt assets and the filing goes through, they will discharge your debts.
To qualify, you need to prove that you can’t repay your debts. You can do so by showing that your current monthly income is less than or equal to the median income in your state for your family size.
If your income is too high, you can still qualify via the “means test.” It looks at your larger final picture, including expenses and taxes. If you don’t qualify, chapter 13 bankruptcy is an alternate option.
The chapter seven filing process
If you do qualify, the process involves the following steps:
1) File a petition with the bankruptcy court in your local area.
2) Provide the court with a schedule of liabilities and assets, current income and expenditures, executory contracts, and unexpired leases. Additionally, you need to provide a statement of financial affairs.
3) Give the trustee your tax returns for prior years and those undergoing filing during the case.
4) Submit proof of credit counseling and any debt repayment plan you create during the counseling.
5) Submit additional proof of income and financial accounts.
6) Pay a $245 filing, a $75 miscellaneous administrative fee, and a $15 trustee surcharge (can be waived in certain cases).
What happens after filing bankruptcy?
Once you file, “automatic stays” applies. This means that creditors can’t contact you to collect what you owe anymore. Initiation or continuation of lawsuits, wage garnishments, and phone calls from creditors will stop. All of your property and debts are handed over to the bankruptcy court.
You will also have to visit the courthouse for a creditors meeting 21 to 40 days after filing the petition. This is a meeting of the bankruptcy trustee and your creditors. During it, you will be sworn in and will answer questions about your financial affairs and property.
The trustee will determine if your case is an abuse of chapter seven or not, and will identify if you have any property that is not exempt from liquidation. The trustee’s goal is to repay as much as possible to creditors from your assets. A decision will be made and given to the court within 10 days.
After the bankruptcy process is complete, all qualifying debts will be gone. The exceptions are child support, tax debts, student loans, secured debts you are paying, and debts which are not dischargeable due to reasons such as fraud or malicious acts.
Chapter seven pros and cons
Compare the pros and cons to make a better decision.
- Shorter process than other bankruptcy types
- Discharge debts relatively quickly, restart building credit right away
- No requirements for a repayment plan
- No limit on debt amount or solvency
- In many cases, a debtor’s assets are exempt from liquidation
- Grounds for denying an individual debtor a discharge are narrow
- Easier to explain to future lenders than a list of debt payments, repossessions, and defaults
- Can lose property you own
- Will lose credit cards
- Must undergocredit counseling
- Some types of debts cannot be forgiven (liens on property, taxes, etc.)
- Case is subject to approval (cannot be considered an abuse of the law)
- Must meet eligibility requirements
- Stays on credit report for 10 years, three years longer than chapter 13
- Can’t file bankruptcy again for six years
- Case may undergo conversion into chapter 13
- On public record
Now let’s look at chapter 13 bankruptcy.
Chapter 13 debt relief
Chapter thirteen is a bit different. Instead of canceling debts and possibly repaying them through the sale of qualifying assets, you use your income to make payments toward a portion of your debt.
It’s also known as the “reorganization” bankruptcy or the “wage earner’s” plan. If your income is under the median in your state, you get a three-year plan. If it is over, you will get a five-year plan.
You have to make enough income to meet the payment obligations. Further, your secured and unsecured debt obligations have to be below the maximum set limits. The maximum limit for unsecured debt is $394,725, and $1,184,200 for secured debt.
The chapter thirteen filing process
The process for filing chapter thirteen bankruptcy is the same as filing for chapter seven. However, you are required to set up a repayment plan.
What happens after you file?
Once you file, efforts on the part of debtors to collect from you will stop, like with chapter seven.
While repaying your debts in full is not a requirement, you will need to use your disposable income to make payments toward it. Certain debts take precedence over others.
At the top of the totem pole are alimony, child support, some tax obligations, and employee wages. Next, are regular payments on secured debt and then unsecured debts you have fallen behind on.
When the plan ends, any remaining debts will be eligible for discharge as long as you are current on any child support or alimony payments and you have completed the credit counseling course.
One of the most prominent benefits is that chapter 13 stops foreclosure proceedings and allows you to pay your mortgage back over time. You can also reschedule other secured debts and extend them over the payment plan.
Total cost= $310 in filing fees plus repayments according to the plan you create.
Pros and cons of filing chapter 13 bankruptcy
Compare the pros and cons to make a better decision.
- Save your house from going into foreclosure
- Keep all your nonexempt assets
- Discharge remaining debt after repayment plan finishes
- 13 bankruptcy comes off of your credit report three years earlier than chapter seven
- Have to make payments on debts according to repayment plan
- Longer bankruptcy process of three of five years
- Bankruptcy appears on your credit report for seven years
- Must undergo credit counseling
- On public record
If you would like to avoid a bankruptcy on your credit report and the filing process that goes with it, debt settlement may be better for you.
What is debt settlement?
A debt settlement is when the debtor pays the creditor a percentage of their total balance to settle the debt. It is also known as credit settlement, debt negotiation, or debt arbitration. Only unsecured debts are eligible, such as personal loans, credit cards, and medical bills.
How does a debt settlement work?
The process of debt settlement is as follows:
- Contact the creditor
- Explain your situation and request a debt settlement
- Come to an agreement, get it in writing, and pay the amount
Key things to know before calling
There are a few things you should know before calling up your creditor, such as:
They don’t have to agree to any debt settlement
The only reason they will is if they think doing so will protect their bottom line. If you are struggling to keep up with the payments and are likely to default, it is in the creditor’s best interest to take a lump sum from you.
They can see your transactions and credit report
Remember the creditor will be able to look over your recent transactions and your credit report. This can work for you or against you. For example, if you are spending money at nice restaurants and keeping up with all of your other obligations, creditors won’t believe you are struggling.
It’s best to stop using the card several months before calling in for a settlement. It will also likely work to your advantage if you have been struggling to keep up with your payments.
Everything is negotiable – Even debt
Remember, this is a negotiation. It’s best to start with a low offer, around 30% of your balance, and try to settle for 50% or less. It may also help to mention that you are trying to settle with multiple creditors, as it will create competition for your money.
Debt settlement companies or DIY
Some debtors enlist the help of debt settlement companies to help them settle their debt. “Now regulated by the Federal Trade Commission (FTC), these businesses work on a consumer’s behalf to lower the principal balances they owe. Final agreements can obtain savings of 50% of the total debt (before fees),” says Andrew Housser, Co-CEO of Freedom Debt Relief.
Housser explains, “A debt negotiation firm does not make monthly payments to creditors, but rather negotiates directly with the consumer’s creditors while the consumer accumulates funds for the settlement through a monthly program payment.
Debt negotiators charge consumers a fee for their services, typically a percentage of the debt enrolled or a percentage of the debt reduced. These fees must be charged after the firm has successfully negotiated the debt.”
While you can do it on your own, an expert that handles settlements regularly can help. But make sure to choose wisely and ask the right questions, as this type of company is known to have some bad apples that prey on struggling debtors. Whether you decide to handle the negotiations yourself or have a company do it for you, be sure to get the agreement in writing. You don’t want the account going to collections after paying a lump sum to settle.
You may be wondering, “How much does debt settlement affect your credit score?” Like a chapter 13 bankruptcy, a debt settlement will stay on your record for seven years.
Total costs: A percentage of your debt, and the payment to the debt settlement company (if you use one).
Here are a couple of things to consider when looking for a debt settlement company.
Do they have minimum and maximum limits on the amount of debt you can enroll?
Most companies require you to have a minimum amount of debt, which is usually around $10,000. Some lenders, such as Freedom Debt Relief, accept lower amounts. Other companies also have a maximum amount of debt you can enroll, such as $100,000. You will need to find a company with requirements that match your needs.
What is their customer service like?
We typically don’t care about the customer service of a company until we run into problems or have questions. It is important to find out ahead of time about the level and quality of support provided by a company. You can do so by researching the support channels they offer (phone, email, live chat, etc.) and by reading reviews from past customers. Look for companies like Debtmerica Relief and Rescue One Financial which are recommended by our community of users. Other debt settlement firms to consider are Pacific Debt and National Debt Relief.
While debt settlement can help you avoid bankruptcy and an account going into collections, it does have its drawbacks. Here’s an overview of the pros and cons.
Is a debt settlement a good idea?
Compare the pros and cons to make a better decision.
- Settle the debt for a percentage of the amount you owe.
- Can typically resolve all debt in two to four years.
- Only pay for services after debt gets resolved.
- Repayment terms are typically better than with a Chapter 13 bankruptcy.
- Heavily impacts your credit report for two to four years.
- Collection agencies or creditors can continue to contact you and can take legal action.
- Stays on credit report for seven years.
- Negatively impacts your credit score.
- You have to save up a lump sum.
- You have to settle with each creditor.
- Have to pay debt settlement company if you hire one for help.
In addition to bankruptcy and debt settlement, there are three other consumer debt relief programs. These include debt consolidation, a debt management plan, and a balance transfer.
Debt consolidation involves combining debt from multiple sources into one loan, resulting in one easy-to-manage payment. Best case scenario, you get an interest rate on the consolidation loan that is lower than the average of all the rates you were previously paying. The drawback is that you may not be able to get approved for a high enough amount or a low enough interest rate if your credit is in bad shape.
A balance transfer involves transferring a balance from one account to another to reduce the interest rate. It is typically a good option if you have a credit card with a high interest rate. You can potentially transfer the balance to a card with a 0% APR promotional period.
Debt management plan
A debt management plan (DMP) typically involves a debtor working with a credit counseling agency to develop a debt repayment plan. The agency then presents the plan to creditors and requests to lower the interest rates and fees. Then, the debtor makes the payment to the agency, which pays the creditors. The plans typically last for four to five years.
Find the right debt solution for you
Debt relief programs work for many people. However, the right solution will vary from person to person. You will need to examine your situation and carefully weigh the pros and cons of each option.
Chapter seven bankruptcy might be the best route for someone with numerous delinquent accounts who meets the eligibility requirements and doesn’t have any nonexempt assets they care to keep. It is fast, affordable, and lets you get a new start quickly. However, Housser says, “This should generally be considered a last resort, as it destroys a credit rating for many years.”
Chapter 13 bankruptcy may be best if you don’t qualify for chapter seven, have assets you want to keep, and have both secured and unsecured debts. It will also look better to future creditors than a chapter seven filing and can help you save your house.
Lastly, debt settlement might work best for someone who has fallen behind on only unsecured credit accounts and has nonexempt assets they want to keep. It will likely be more affordable than a Chapter 13 repayment plan and will come off the credit report sooner than Chapter 7.
To see if you qualify for debt settlement (without hurting your credit score), click here. You can also browse our list of top debt settlement companies to help you find the best one for your situation.
Jessica Walrack is a personal finance writer at SuperMoney, The Simple Dollar, Interest.com, Commonbond, Bankrate, NextAdvisor, Guardian, Personalloans.org and many others. She specializes in taking personal finance topics like loans, credit cards, and budgeting, and making them accessible and fun.