Many people ask me which is better Bankruptcy, or some form of credit consolidation or debt settlement. In the vast majority of cases, Bankruptcy is the superior choice. There may be some people who are so wealthy, or whose incomes are so high, that Bankruptcy is not a good option. However, those people are also going to have some difficulty in negotiating a reduction in their debt as well. For people who qualify for some form of Bankruptcy protection, and most people with unmanageable debt do, Bankruptcy is the clear choice. Bankruptcy is more likely to lead to a successful outcome. Bankruptcy is less likely to result in tax problems. People’s credit will generally recover more quickly from a Bankruptcy filing then from any kind of private debt restructuring plan, and bankruptcy is generally more affordable.
When I was a young lawyer, people would ask me to try to negotiate with their creditors. What I found was that there were always a few creditors who were reasonable and willing to make a deal, and there were a few who were not. The ones who were not would ruin it for the rest. In other words, I could negotiate a reasonable payment arrangement with some, but others would want everything and the client could not afford it. There is no way to force a creditor who wants to assert all of their rights to make a deal. While the United States Bankruptcy Code is an Act of Congress and the law governing theUnited States, debt consolidation and credit counseling and what not are voluntary arrangements between the debtor and creditor. There is no state or federal program, other than Bankruptcy, that reduces or eliminates credit card debt. I once had a client come to me who had been making payments to one of the debt reduction services for a little over two years. One of her credit card companies sued her. She called them up and told them that she was dealing with whatever agency, and the representative of the credit card company said ‘yes, but we are not’. In other words, that bank simply chose not to participate in the debt reduction program, but instead chose to sue for the entire balance owed on the credit card, plus interest and fees which had accrued, plus attorneys fees which are often allowed under the terms of the credit agreement. I have had a number of cases where people came to me after making substantial payments to the debt consolidation service, only to find that not all of the creditors were playing along.
The debt negotiation agencies are not so up front about the tax consequences of what they are doing. Any time that a bank forgives or reduces a debt, the IRS treats that as taxable income. In other words the IRS believes that when Citibank allows you to pay $6000 to settle a $10,000 debt, that is the same thing as Citibank giving you $4000. With Bankruptcy, there is no such tax consequence. Consumer debts discharged in Bankruptcy are not treated as taxable income. Neither are most business debts.
I hear the commercials on the radio for the debt negotiation services that say “don’t ruin your credit filing Bankruptcy”. They should say after that, “instead ruin your credit with us.” Putting aside for the moment that the impact on the creditworthiness of people who file Bankruptcy is generally exaggerated, the impact on people who engage in any form of debt negotiation is commonly ignored. Either you are paying your bills in full and on time, or you are not. If you are paying your bills like you originally promised, then you will have good credit. If you are not, then you will not. Generally speaking, people in Bankruptcy and any kind of debt negotiation, are already behind on their bill payments, and thus already have bad credit. Others know that they will not be able to maintain their payments indefinitely, or perhaps are “robbing (or borrowing from) Peter to pay Paul” and thus file Bankruptcy or go to the debt negotiator in anticipation of being unable to pay their bills anyway. The low credit score that results is not the fault of the Bankruptcy filing, or of the debt consolidation, but instead is a result of the fact that you are not able to pay your bills as originally agreed. So the relevant issue is not which one “ruins” your credit, but from which one can your credit recover faster?
The answer to that question is almost always Bankruptcy, especially when the Bankruptcy filing is under Chapter 7. The reason for this is very simple. A Bankruptcy filing is a discrete event. You file for Bankruptcy, and from then on you look at it through the rearview mirror. One year later, you are one year post-petition. Three years later, you filed Bankruptcy three years ago. It quickly loses its importance, even if it is still on your credit report. As long as you are working and paying your bills on time, your credit is improving. However, if you are in a debt reduction program, you are continuing not to pay your bills in full and on time for a period of years. During these years, more negative information is going on your credit report. As a result, your credit is not improving, but is actually getting worse over time. What is more, after a Bankruptcy filing you have no debt. As a result, after discharge a bank may decide, and often does, that although you cannot handle the amount of debt that you discharged, you might be able to handle a few thousand dollars worth of credit card debt. As such, right after discharge people often do receive fresh credit and can use that to rebuild credit faster. Under debt consolidation plans, you are already paying everything that you can possibly pay, and thus cannot get any fresh credit. Finally, after filing Bankruptcy, you can begin to save money. If you are in a debt consolidation plan, then you are paying several hundred dollars a month to the debt consolidator, and thus cannot save money. There is no better way to get a loan, then the prove you do not need it. All creditors feel more comfortable lending when you have cash in the bank. Finally, mortgages under various federal programs, and even conventional mortgages, can be obtained within a few years of filing, even though the Bankruptcy is still on your credit report.
Finally, debt consolidation or debt negotiation or whatever they are calling themselves this week is simply more expensive than Bankruptcy. First of all, the fees are higher. They disguise their fees by simply taking your first several monthly payments. If you quit one of these plans after three or four months, all you have done is pay fees and nothing has gone to your creditors. Given that I am very flexible about payment plans, the fact that they are being paid monthly is of no advantage. My fee may be paid over several months as well. However, mine is usually lower. More importantly, in Chapter 7, my fee and the costs of filing which I collect as part of my fee is all that you will pay. If you qualify for Chapter 7, there is no reason to be making years of payments to one of these companies. Some of these companies advertise that they can reduce your debts by 50%, but only Bankruptcy can reduce your unsecured debts by 100%.
At the end of the day, Bankruptcy, especially Chapter 7, can save you more money for less cost with fewer consequences while helping you to rebuild your credit quicker. What is more, once you qualify, Bankruptcy is certain to succeed, while debt negotiation programs can only try. As a result, it is very easy to answer that in almost all circumstances, Bankruptcy is the superior choice to any of the debt consolidation or debt negotiation or debt reduction programs out there.