02 Apr Are debt settlement or debt consolidation worth doing?
In a published article in Smart Money, Debt Settlement: A costly escape, it enumerates the dangers of debt settlement or debt consolidation. After verifying the information published from other sources and corroborating the information with my personal experience I summarized the various findings as follows:
- Many creditors will escalate collection efforts once they know that a debtor is in debt settlement. They will send the account to a collection agency who will file a lawsuit to recover any money. When the creditor takes legal action, the debt settlement companies will likely drop the account because they have to right to give legal advice or to represent a debtor in court.
- High fees. Debt settlement companies’ charges vary. Some charge a flat fee of $5000 or more. Others charge about 15% to 18% of the total debt. On the other hand some charge about 25% of the savings. In the final analysis, sometimes it becomes more expensive than paying the creditors’ directly.
- Any debt forgiven must be reported to the IRS as income. If your forgiven debt is $100,000 the federal income tax and state tax could be a staggering $50,000.
- Some debt settlement companies do not do anything during the first two or more years of your contract. They are accumulating the monthly payments you are sending to their escrow account before starting negotiation. Meantime they are withdrawing their fees.
- High dropout rates. Many consumers drop out of the contract before the company reaches a settlement with creditors. I have many bankruptcy clients who paid thousands of dollars to debt settlement companies but they have not reached any settlement. This made them to decide to file bankruptcy.
Question: Can I file bankruptcy while in the process of debt settlement?
Answer: If you are in debt settlement you can still file bankruptcy. Bankruptcy can cancel any contract you made on debt settlement without any problem. Filing bankruptcy could take between three to six months to process. Once the case is filed, no creditors will make a collection call or file a case in court because you are protected by the automatic stay of the court.
Question: What are the advantages of filing bankruptcy over entering into debt settlement?
Answer: By filing bankruptcy, you can eliminate all unsecured debts that cannot be eliminated in debt settlement. No creditors can sue you anymore or hold you personally liable on all your unsecured debts. Attorney’s fees are cheaper than fees for debt settlement. If you file bankruptcy, there will be no more garnishment, no long period of negotiation and no reporting of income to the IRS. After your discharge from bankruptcy you can start fresh and begin building your credit which you can improve within one to two years. In debt settlement, you need to be late on payments for about six months before negotiation with creditors can start and you cannot build your credit until all debts are settled which may take years.
Note: This is not a legal advice.