Debt settlement vs bankruptcy – 7 Tips to choose the right option

By Good Nelly

Ask Nelly

If you're drowning in debt and bankruptcy seems to be the only way out, think twice as there are alternatives which can help you pay off bills fast without affecting your credit as severely as bankruptcy. Debt settlement is one such alternative. It enables you to get out of debt legally by allowing you to pay much less than what you actually owe.

Debt settlement vs bankruptcy - Tips to help you make the right choice

Check out 7 things you should do to decide upon debt settlement vs bankruptcy.

1. Check your credit report: Find out what negative items (such as late payments, collections, charge-offs, etc) you have on your credit report and on which accounts you still owe money. This will help you determine the extent of your indebtedness.
2. Calculate your total debt: Determine how much you owe in total. Add up the outstanding balances on your credit accounts including those which are in collection.
3. Calculate income from all sources: Determine your total monthly income including paycheck, bank savings, rental income, alimony/child support, investment returns, etc.
   
   If your income doesn't exceed the amount paid towards your basic financial needs including housing expenses, utility bills, gas, groceries, etc., then you shouldn't go for settlement. This is so because you can hardly save anything to settle your bills with a lump sum payment after a certain period of time.
   
   However, if you've thought of filing bankruptcy, calculate your average monthly income for past 6 months (gross monthly income divided by 6) preceding the month you file bankruptcy. The average monthly income is compared to your state median income to find out whether you qualify for Chapter 7 or 13. Moreover, you need to find out whether you can afford the costs of filing bankruptcy.
4. Check if you qualify for settlement: You need to have a certain amount of outstanding balance so as to make a settlement company negotiate with creditors on your behalf. However, this qualifying amount may vary from one company to another.
5. Find if bankruptcy can erase all your dues: It is essential that you verify whether bankruptcy can wipe out all your bills. Not all your bills can be discharged through bankruptcy. So, depending upon your outstanding balance on each account and the type of bills you have, bankruptcy may or may not be the right option for you.
6. Know the consequences of filing bankruptcy: You should be aware of the consequences of filing bankruptcy. A bankruptcy affects your credit score by 200-250 points depending upon what other negative remarks you have on your credit report. It stays on one's credit report for 7-10 years. This is why you may have problem in getting qualified for new credit (such as credit card, mortgage to buy a home, etc) in the next few years. Moreover, if you file Chapter 7 bankruptcy, it may require you to sell your home or car provided they don't qualify for the Federal or State exemptions. Thus, it is better to avoid bankruptcy.
7. Find out if settlement can hurt your credit: If you choose to settle your bills, you're likely to trash your credit score. That's because you may have faced late payments or collections on your accounts prior to asking for a settlement. Stop payments drop down your credit score by 50 points or more depending upon how many payments you've missed and what negative listings you have on your credit report. But there are easy ways to repair your credit after settlement.
   
   In certain cases, you can save your credit from being trashed even after settlement. This is possible when creditors or collection agency agree to report your account status to the credit bureaus as "Paid in full" or when they sign on a pay for delete agreement. Under this agreement, once you settle an account, your creditor or collection agency removes the account listing and any negative remark from your credit report. This saves your credit from getting a hit.

What to do when you can't settle bills or file bankruptcy

It may happen that you do not qualify for bankruptcy filing or you may not find settlement as a viable option to get rid of bills. In such a situation, you may choose to consolidate bills by getting enrolled in a consolidation program or applying for an unsecured personal loan.

When you choose to deal with a third party to settle or consolidate your bills or you hire a bankruptcy lawyer, you'll have to pay certain fees in return of their services. However, if you're confident that you can negotiate with creditors on your own, it'll not only reduce your monthly obligations but will also save you dollars which you may otherwise pay as third-party fee.