Debt Settlement vs Bankruptcy: Which Is Better for Getting Out of Debt?
Struggling with high amounts of debt can feel overwhelming. When you’ve tried budgeting, calling creditors for relief, or consolidating debt yet still face mounting interest fees and calls from collectors, more serious options like debt settlement and bankruptcy may seem like the only way out.But how do you know which route is best? While both debt settlement and bankruptcy can reduce or eliminate debt, they work very differently. Understanding the key differences between these two debt relief methods can help you make the smartest choice.
How Debt Settlement Works
Debt settlement, also called debt arbitration or debt negotiation, lets you settle your debts for less than you actually owe. Basically, you or a settlement company negotiates with your creditors to accept a lump sum payment that is less than the full balance. Creditors may agree to this because they’d rather get something instead of nothing if you file for bankruptcy.
-- With debt settlement, you stop making payments on your debts and instead save up so you can make the negotiated lump sum settlement payment(s). This can take several years.
- There’s no guarantee that all or any of your creditors will accept a settlement offer.
- You’ll continue getting calls from collectors while saving up for settlements. Late fees and interest will continue adding up too.
- Any forgiven debt from settlements may be taxed as income.
So debt settlement can work, but it has some big downsides. The process drags out for years while your debt grows. Plus, nothing prevents creditors from suing you in the meantime.
Understanding How Bankruptcy Works
Declaring bankruptcy legally eliminates or restructures debt you can’t afford. The most common types of personal bankruptcy filings are Chapter 7 and Chapter 13.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy wipes out eligible debt completely. This is known as a straight or liquidation bankruptcy.
- Virtually all unsecured debt like credit cards, medical bills, personal loans, etc can be eliminated. Certain assets may be sold by the bankruptcy court to pay creditors.
- The whole Chapter 7 process typically takes 3-6 months.
- Bankruptcy stops collections activity cold with an automatic stay. Debt collectors must cease contact immediately. Wage garnishments also end.
- Chapter 7 bankruptcy remains on your credit report for 10 years. You can rebuild credit after about a year though.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy sets up a 3-5 year repayment plan for your debt. It’s commonly known as a wage earner’s plan or reorganization bankruptcy.
-- Rather than wiping debt out as with Chapter 7, the court approves a new payment plan to catch up on debts.
- Payments under Chapter 13 are often less than what you originally owed across multiple accounts.
- Chapter 13 stops collections and wage garnishments too.
- As with Chapter 7, Chapter 13 bankruptcy stays on your credit report for 10 years.
Either type of bankruptcy requires that you pass a means test to qualify. This looks at your income, living expenses, and secured debts like mortgages or auto loans. But once you file, all collections activity halts immediately with federal legal bankruptcy protection.
Key Differences: Debt Settlement vs Bankruptcy
While both debt settlement and bankruptcy can reduce financial burdens, they work very differently:
- Debt Settlement
- Private process between you and creditors
- No guarantee of settlements
- Typically takes years to complete
- Debt & fees continue mounting
- Risk of getting sued
- Possible tax implications
- Bankruptcy
- Federal court-managed process
- Immediate halt to collections
- Over in months (Chapter 7) or years (Chapter 13)
- Stops wage garnishments
- Long-term credit score impact
Bankruptcy protection also starts instantly upon filing, while debt settlement provides no legal shield from collections. Debt settlement may also not resolve all your problem accounts if some creditors won’t negotiate.
Is Debt Settlement or Bankruptcy Better for You?
There’s no one-size-fits-all answer to whether debt settlement or bankruptcy is the better choice. It depends entirely on your personal financial situation.Those barely keeping up with everyday expenses can get quick relief from harassing collections through bankruptcy. Settlement may work better for those with some savings able to endure a longer process.You can discuss your specific circumstances with a nonprofit credit counseling agency like InCharge Debt Solutions. Their certified counselors can help you review all debt relief options to find the right solution.If you do decide bankruptcy makes more sense, it’s smart to meet with a bankruptcy attorney. Attorneys are familiar with exemptions and other regulations that determine how bankruptcy will impact your property and assets. They also help ensure all the required paperwork gets filed properly with the court.
Making the Best Choice for Your Situation
When you simply cannot keep up with debt payments month after month, taking action is critical. Both debt settlement and bankruptcy offer ways to resolve debts you can no longer afford to pay. Consider all factors carefully, from cost to credit impact and beyond.Getting educated on how each debt relief method works can help you make the smartest decision. Finding an experienced credit counselor or bankruptcy attorney to discuss your specific situation is also wise.While debt feels overwhelming now, know that relief is possible, and brighter days lie ahead. Weigh both bankruptcy and settlement as options so you can take control of your finances again.
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