Last updated on April 24th, 2023 at 10:06 am
Both debt settlement and bankruptcy should, without a doubt, be considered as a very last resort. However, for some consumers, they can provide a way out of an otherwise unmanageable debt situation.
Nevertheless, while they may be considered a path to reorganising your assets and starting to repair your financial situation, it is absolutely crucial to understand the costs and impact on your short- and long-term credit health before deciding which option is right for you.
Debt settlement and bankruptcy are potential solutions to the same problem – getting people out of debt in a direct way. The similarities between the two end there, though, as the consequences and the processes for each are vastly different.
Choosing the best course of action will depend on your unique financial situation. That is why consulting with professional insolvency practitioners can help you better understand all options at your disposal. After all, debt settlement or bankruptcy should only be considered when all other available options, such as credit counselling, debt management plans, debt consolidation, and others, have been exhausted.
It’s true that debt settlement and bankruptcy are not ideal solutions for financial recovery, but if you’re deeply in debt, they may be worth considering in order to regain control of your finances.
Although bankruptcy can provide a quick solution to debt problems, it has a significant negative impact on credit ratings in the long run. The bankruptcy record can remain on credit reports for up to a decade, potentially making it harder to secure loans, credit cards, or mortgages. There are typically two types of bankruptcy cases – one which clears personal debt, and one that involves a repayment plan usually lasting between three and five years and is managed by a federal court.
In contrast, debt settlement is an alternative option that does not require court intervention and can often be handled without legal or financial advice. A settlement is an agreement reached with creditors to pay less than the total owed, typically through a lump-sum payment.
What motivates creditors to agree to settle your debt for less than the full amount is the fact that they realise that if you declare bankruptcy, they may lose the opportunity to collect any payment at all. Consequently, creditors are often willing to accept a lesser amount through a debt settlement agreement, however, not all may be open to such an arrangement.
If you determine that the negotiated reduced payment from a debt settlement is still unmanageable for you, declaring bankruptcy may still be the better option.
While debt settlement may have a relatively lesser impact on credit score compared to bankruptcy, it still comes with its own set of disadvantages.
For example, it’s important to understand that creditors are not obligated to negotiate with you, and stopping payments to demonstrate your commitment to not paying may result in your accounts being sent to collections or legal actions being taken against you. This could worsen your credit score and further increase your debt due to the accumulation of late fees and interest. At the same time, don’t expect collection contacts to stop – whether it’s through phone calls, mail, or email, they won’t be pleasant.
If you decide to halt payments to save money for a lump-sum offer, your debt may become larger due to penalties and interest. Furthermore, depending on the specific laws, settling a debt may result in tax agencies treating the forgiven amount as income, which will, in turn, result in additional tax obligations.
Additionally, debt settlement companies may charge steep fees, and some creditors may not be willing to cooperate with the specific company you have chosen to represent you. It’s also important to note that debt settlement will still negatively impact your credit rating significantly and make it more difficult for you to secure loans in the future.
First of all, initiating the process and filing for bankruptcy can be costly, with attorney fees adding up to thousands of dollars in addition to any applicable filing fees.
Bankruptcy can have long-lasting negative consequences for credit scores and reports, with the bankruptcy record remaining on your credit report for quite a few years. Although credit scores may start to recover after the debt is discharged, maintaining positive payment behaviour is crucial. It’s important to note that not all debt can be eliminated through bankruptcy, and many, including student loans, child support, alimony, and most back taxes, will still remain outstanding.
It is also critical to keep in mind that, unlike debt settlement which is a private arrangement, bankruptcy proceedings are public information. As a result, they could harm one’s financial reputation and impact future job opportunities or rental prospects. This is a significant drawback to consider when contemplating filing for bankruptcy.