Debt settlement and bankruptcy are solutions to the same problem – what are the most direct methods to get out of debt?— but they each come with their own advantages and disadvantages, and choosing the right one can be tricky. If your debts are so massive that you can’t imagine repaying them, it’s time to evaluate both options as you look to restore your credit health and financial well-being.
Bankruptcy can offer the fastest path out of debt, but the long-term impact on your creditworthiness is severe. A bankruptcy will stay on credit reports from s 7-10 years, which will greatly impede your ability to get a loan, receive a credit card or buy a home Bankruptcy, which is adjudicated in federal court, either wipes out your personal debt (Chapter 7) or creates a 3-5 year plan for repaying creditors (Chapter 13).
Debt settlement doesn’t require a court filing and, unlike bankruptcy, can often be handled without a lawyer or financial counseling. A settlement is a deal you negotiate with creditors to pay less than the amount owed, usually with a lump-sum payment
Why would creditors want to settle your debts for less than you owe?
They know that you can always file for bankruptcy, which could eliminate their ability to collect anything from you. So, they are often willing to accept less than they are owed through debt settlement.
If you conclude that you can’t afford even the reduced payments negotiated from debt settlement, bankruptcy could be the best option.
Personal bankruptcy comes in two varieties: Chapter 13 is essentially a payment plan that takes three to five years; Chapter 7 clears your personal debts in 6-8 months, but comes with potential pitfalls. If you own a home, you will be able to keep it under Chapter 13, though you will need to make mortgage payments after you exit bankruptcy court. Chapter 7 doesn’t offer that guarantee. Depending how much equity you have in it, your home might qualify as exempt in some states, but others allow bankruptcy trustees to sell your home to raise money to repay creditors. Chapter 7 also requires you make less than your state’s median income (half salaries above the number, half below) for a family your size.
Bankruptcy frees you from debt collection, but the headaches can linger for years. Debt settlement without bankruptcy can take more time but, if negotiated properly, can do far less damage to your credit. Understanding the pros and cons of debt settlement vs. bankruptcy and making the smartest choice can have a big impact on your future finances.