Is it better to file bankruptcy or settle debt?

Debt settlement and bankruptcy are the two major options of last resort for people with unmanageable debt, especially from credit cards. It is better to pursue debt settlement when you want to minimize damage to your credit score and when avoiding the stigma of bankruptcy is important. It is better to file bankruptcy if a faster debt resolution with a greater chance of success and less frequent creditor communication and are top priorities.

While debt settlement and bankruptcy can both make it easier to get out of debt, the means used to get to that point vary considerably. Debt settlement involves negotiation between the debt holder, their debt settlement company (if applicable), and creditors. These parties agree to a debt settlement below the original account balance and the remainder is forgiven.

When it comes to bankruptcy, consumers can choose between Chapter 7 and Chapter 13. Chapter 7 bankruptcy involves a liquidation of assets to resolve debt, while Chapter 13 consists of debt restructuring and the creation of a new payment plan. Both types require the parties involved to go to court, where a judge makes determinations based on financial records including pay stubs and credit card bills.

In order to help you determine which process is the best fit, some statistics on process length, cost, success rate, and credit impact are detailed below.

Bankruptcy vs Debt Settlement:

 In terms of speed and success rate, Chapter 7 bankruptcy is the best choice. Debt settlement has a low success rate, but it creates the least amount of credit damage. Chapter 13 bankruptcy requires a greater time commitment than debt settlement, but you can expect a higher chance of success.

When deciding between these alternatives, you may also want to consider some characteristics that are not as easily quantified. The following guidelines should help.

Either form of bankruptcy is preferable over debt settlement when:

• You want creditors to leave you alone. When you begin bankruptcy proceedings, your creditors will be notified so they will stop actively pursuing repayment.
• You want a more straightforward solution to debt. Bankruptcy has a greater chance of success and involves less risk than debt settlement.
• You have secured debt. Debt settlement can technically occur with secured debt, but it is much more difficult since it would involve handing over the collateral tied to the debt.

Debt settlement is better than bankruptcy when you:

• You are behind on payments. If you are already behind on payments, debt settlement might be the best choice because you’ve essentially started the debt settlement process.
• You want to keep things private. If saving face is a top priority, debt settlement is preferable over bankruptcy because it is not a public record.
• You can’t qualify for bankruptcy because of the means test. If you are considering either form of bankruptcy, you will need to pass a means test that examines your income and expenses. If you have a decent amount of income left over after expenses, you will probably not qualify for bankruptcy, since you could use some of your disposable income to pay off your debts.
• You expect your income to fluctuate. When you file for bankruptcy, you are generally obligated to use the bulk of your disposable income (after expenses) to pay your creditors. If you know your income might increase dramatically in the short term, debt settlement might be the best option as it would protect your increased income from your creditors.

Bottom Line:

When deciding between debt settlement and bankruptcy, there is never an obvious choice. It’s best to start with research; see which option makes the most sense for your situation and consider getting a second opinion from a licensed credit counselor. These initial credit counseling consultations are generally free and you can learn a lot about your options.

Either way, always crunch the numbers for every scenario. Make sure you understand what each option would end up costing. And if you employ a lawyer or settlement company, make sure you have a clear understanding of their fee structure.

Finally, once you have a plan in place, stick to it, and work on establishing good financial habits to adopt permanently.