If you are facing collections or repossession, you have probably wondered how to get out of debt quickly. The traditional way to get out of crushing debt is by filing bankruptcy. However, filing bankruptcy is just one option to escape debt. According to Philadelphia-based bankruptcy attorney David M. Offen, debt settlement may be an option if you are several months behind on an account and have cash set aside to pay a portion of the account off immediately.
What is Debt Settlement?
Debt settlement is a process where a company agrees to consider a debt satisfied for some figure less than what you actually owe. Debt settlement and bankruptcy can both eliminate debts for less than the surface value, but they are solutions for different situations and the ramifications of each differ.
Debt settlement is an agreement between you (or a representative, like a lawyer or professional settlement service) and the creditor or creditors you owe money to. The idea of settlement is to offer a compromise that satisfies the creditor without making you pay the full debt.
Let’s say you owe $5,000 to a local community hospital. After several months of non-payment, they probably threatened to send the debt to collections. But that’s a long, expensive process for them. If you can offer them $3,500 right now, they might be willing to forget the difference and call the debt settled.
Advantages of Debt Settlement
There is a significant advantage to debt settlement over bankruptcy. For one, you won’t have a bankruptcy on your credit report. Missing payments and carrying high monthly balances will hurt your credit no matter what. Resolving them through any means other than paying in full will also hurt your credit, but as much…?
Credit agency FICO is fairly open about the impact of debt settlement vs. filing bankruptcy. An individual with an average (680) score would lose 45-65 points if they used debt settlement on their outstanding accounts. If that same person filed for bankruptcy instead, they would lose 140 to 160 points.
The impact is even worse for someone with prime credit. With a score of 780, a debt settlement would knock 120 points off your score. Bankruptcy? 220 to 260 points. A difference of more than 100 points between settlement and bankruptcy translates into ridiculous interest rates on future credit for years to come, trouble securing housing, and even employment problems if you work under a security clearance.
Disadvantages of Debt Settlement
There also disadvantages, one being that if you have more than one creditor and not all are on board with debt settlement, one creditor may still sue you for the full amount while you try and pay the others a negotiated amount.
Another disadvantage is the tax treatment of forgiven debt – the IRS counts it as income and you will pay income tax on it. Not only that, but you will likely be in a higher tax bracket due to forgiven debt, and you will pay a greater percentage of your income in taxes.
Last, debt settlement only works if you actually have cash on hand to pay once a settlement has been reached. For many people, especially those who used credit cards irresponsibly or suffered a medical emergency with bad insurance, the money simply isn’t there, and never will be.
Settling Old Debts
Debt settlement can be very successful when an old account is sold off to debt buyers. Agencies who specialize in collecting on old accounts may buy your old credit card debt for a few cents on the dollar. Medical debt is often the cheapest, traded in portfolios for as low as a penny on the face dollar value of the debt. In simple terms, a collection agency could buy a $1000 debt for $10 or $11.
When those agencies start to hound you about it, they’ll try to collect as much of the debt as they can, and no matter what they paid, they do have the legal right to collect the full value of the debt. After a lot of negotiation, they may finally agree to knock that medical debt down to $350 if you can write a check right now. You get the debt monkey off your back, and the collection agency makes a handsome profit for their trouble, even if you pay less than half the face value of the debt.
Is debt collection or bankruptcy is right for you? Take advantage of a free consultation with a local experienced bankruptcy attorney to find out.
About the Author:
Veronica Baxter is a writer, blogger and legal assistant operating out of Philadelphia.