What’s the Difference Between Bankruptcy and Debt Settlement?

Right now, many American consumers are struggling with surging debt.

As such, more and more people are filing for bankruptcy and subsequently lessening the previous stigma around it. And with good reason. There are so many reasons one might find themselves in debt that have nothing to do with one’s character.

Whatever the case, Americans struggling with paralyzing debt are considering the difference between bankruptcy and debt settlement to get themselves back on the road to financial recovery.

The Difference Between Bankruptcy and Debt Settlement

While both bankruptcy and debt settlement offer ways to manage crushing debt, there are differences and we’re here to break them down for you.

What Is Bankruptcy?

In a nutshell, bankruptcy helps individuals or businesses who cannot pay their debts get a new financial start. This is achieved by either forgiving those debts or by setting up a workable and reasonable repayment plan. Any debt discharged in bankruptcy is not subject to income tax.

One of the big benefits of bankruptcy over debt settlement is that you are legally represented by an experienced attorney from a bankruptcy law firm. Because your attorney will assert your legal rights under the U.S. Bankruptcy Code, you are protected from collection actions and lawsuits. You also attain the right to sue any creditor who attempts collection after you’ve filed for bankruptcy.

There are two basic categories for Individual bankruptcies:

1. Chapter 7 Bankruptcy

Chapter 7 bankruptcy is considered the most straightforward and is the best choice if you have few assets, yet a lot of unsecured debt from medical bills or on credit cards. The process of clearing most of your debts and getting a fresh financial start typically takes less than six  months.

While most assets are protected from liquidation under Chapter 7, high-value assets such as coin collections or investments might be sold off to partially pay back creditors. You will also be subject to a means assessment to ensure that you qualify for Chapter 7 bankruptcy.

The impact from filing for this type of bankruptcy will show up on your credit report for ten years. Plus, you’ll have to wait eight years before filing again under Chapter 7 for bankruptcy relief.

2. Chapter 13 Bankruptcy

By contrast, if you have assets but also a steady income, you would likely benefit more from a Chapter 13 bankruptcy. In this case, your debt loads are reorganized under a court-supervised payment plan that lasts on average between three to five years. At the end of that payment period, any remaining balance is discharged.

Chapter 13 is better for those with major assets because it protects your property, including your car and house, from liquidation, repossession or foreclosure. While this bankruptcy reduces your credit score for couple years and can impact your ability to borrow money or get credit, the waiting period for filing bankruptcy again is only two years.

Meanwhile, What Is Debt Settlement?

Debt settlement is a strategy that falls under the larger umbrella of debt relief. It’s an agreement between the creditor and the borrower wherein each party agrees on a reduced amount to pay off the debt in full. The borrower has the advantage of paying less than what is owed, while the creditor benefits from this partial payment over having to write off the entire balance. When done correctly, you could see your debt balances, interest rates, and month payments become less.

As with bankruptcy, debt relief through debt settlement is not without its drawbacks. If you choose this route, you need to be alert about the significant fees you may be charged, especially by debt-settlement companies. You’ll also face the possibility of creditors who won’t get on board with the process and potentially file lawsuits.

Debt settlement will also have a negative impact on your credit score. And because the IRS considers forgiven debt balances as income – which is the case with debt settlement – you may owe income tax.

All of this is worth serious consideration.

Which One Is Right for You?

At the end of the day, if you’re feeling crushed financially and emotionally by debt with no obvious way out, bankruptcy is typically a better long-term solution with a clearer path back to financial freedom than debt settlement.

If you’re still unsure though, our bankruptcy lawyers can answer any other questions you may have about the difference between bankruptcy and debt settlement.

Contact us today to arrange a free 30-minute consultation and we can discuss which option is truly better for you.