Debt Settlement vs Bankruptcy
There are clear distinctions between debt settlement (debt relief) vs bankruptcy, so it is imperative that one understands an exhaustive list of differences before deciding whether debt settlement or bankruptcy is right for them.
Complete the Debt Settlement vs. Bankruptcy questionnaire to compare Debt Settlement to Chapter 7 Bankruptcy to Chapter 13 Bankruptcy. The output will provide a payment estimate for each options along with pros and cons to each solution.
Introduction
The question whether to pursue debt settlement or bankruptcy is a common question that comes to the mind of those we serve. When you are unable to afford all of your debts, these two options can be the most realistic solutions for your situation.
In this article, I would like to present an overview of the process and the pros + cons of debt settlement + bankruptcy, while giving insight to help you make the most informed decision.
For context, here’s a general definition of each of the things we will discuss:
Debt Settlement: An individual or service working on an individual’s behalf to negotiate your debts by decreasing what is owed if you are unable to afford your debt.
Chapter 7 Bankruptcy: A bankruptcy that wipes away all of your unsecured debt. Student loans generally will not be discharged from any bankruptcies.
Chapter 13 Bankruptcy: A bankruptcy that restructures your existing debt, often due to an individual making too much to file a chapter 7 bankruptcy.
How Debt Settlement Works
Debt settlement companies work as an intermediary between the individual owing the debt and the creditor. The debt settlement company will do the following for the enrolled participant:
- Create an enrollee-owned escrow bank account for the enrollee to consolidate all of the payments into one payment for the creditors.
- Communicate to the creditors that they will be the primary point of contact going forward to prevent future calls to the enrollee.
- Negotiate on behalf of the enrollee with each of the creditors for the lowest possible rate. Get agreement from the enrollee on whether to accept the settlement and payment plan.
- Repeat step 3 for all creditors. Manage the payments to all creditors upon completion and debt freedom.
A few points to note:
- When choosing a debt settlement company, it’s important to observe the fees charged and compare those against other companies, how the fees are paid, and any other fees associated with the program.
- It’s also important to understand the end-to-end process of how the program works and who you will be interacting with throughout the program. For example, Ascend pairs each enrollee with an advisor for the duration of the program.
How Chapter 7 Bankruptcy Works
As stated above, the main difference between Chapter 7 and Chapter 13 bankruptcies is that all your debt is wiped out in Chapter 7 regardless of what you owe. For reference, student loans are generally not discharged in either type of bankruptcy.
To qualify for Chapter 7, you must meet income guidelines based on means testing. This information is determined by the Census Bureau and the Internal Revenue Service. These income guidelines are based on the income based on your family size and the state where you reside. For details, the most recent Census Bureau Median Family Income By Family Size for on or after April 1, 2020 and beyond can be found here. If you earn more than the median, the next step would be to determine whether you have enough left over to repay some of your debt.
A few points to note:
- The higher your disposable income, the more likely you wouldn’t qualify for a Chapter 7 bankruptcy.
- There can be exempt assets that are state specific. The Bankruptcy Site provides a comprehensive list of those exemptions by state here.
- Only bankruptcy filers who have significant consumer debts need to take the means test.
How Chapter 13 Bankruptcy Works
Chapter 13 is another way to get rid of your outstanding debt, but it takes much more time and is more involved. Since a Chapter 7 bankruptcy can be completed in under 1 year, a Chapter 13 bankruptcy can take up to five years. There are also limits as to how much debt you can include.
When you file a Chapter 13 bankruptcy, it can be similar to a structured settlement plan in a debt settlement in that you have to pay some or all of your debts. The amount that you pay typically depends on the type of debts included in the bankruptcy and how much you owe to your creditors. There is also a waterfall of payment priority with the first payments made to your lawyer(s) and the lowest priority to your unsecured creditors.
The benefit of a Chapter 13 bankruptcy is that you may get to keep some of your assets, as there are some protections by state.
A few points to note:
- A Chapter 13 bankruptcy can last three or five years, but the majority will be five years.
- There’s an incentive to stay in the bankruptcy. If you fail to make the payments to the trustee, the case can be dismissed, leaving you to owe your creditors again, and the fees to your legal assistance, trustee, etc. would generally not be refunded.
- The Chapter 13 payment plan is highly inflexible, meaning that unexpected emergencies can mean a dismissal of the bankruptcy.
Debt Settlement vs Bankruptcy
Below is a breakdown of the pros and cons of debt settlement vs bankruptcy with estimated positive or negative weighting for each of the different options.
| Attribute | Debt Settlement | Chapter 7 Bankruptcy | Chapter 13 Bankruptcy |
|---|---|---|---|
| Damage to Credit Report | Medium (7 Years, No Bankruptcy) | Highest (10 Years) | High (7 Years - No Credit During) |
| Damage to Credit Score | Medium | High | High |
| Payment Flexibility | High | Low | Low |
| Time | 2-4 Years | 90 Days | 3-5 Years |
| Legal Protection | Medium | High | High |
| Qualification | Yes | Yes | No |
| On Public Record | No | Yes | Yes |
| Taxes on unpaid debt | Potentially (>$600) | No | No |
| Property Protection | Yes | No | Yes |
| Fees | 20-25% of Enrolled Debt (Ascend = 15%) | $500-$2000 | $2500-$6000 |
| Success Rate | Low to Medium | High | Low to Medium |
What's Best For You?
This depends on each situation and each individual. At Ascend, we would prefer to have a conversation with you beforehand to determine what’s best for you. We want only those suitable for the Ascend program to be enrolled (which is a very small subset of the population), so there is no bias to offering a recommendaion that does not suit you well.
Complete a short questionnaire to see which solution is best for you!
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