As consumers are still feeling the economic impacts of higher prices caused by inflation and increased borrowing costs from higher interest rates, many are seeking debt relief options. The two main forms of debt relief available are bankruptcy and debt settlement.

For debtors that pursue bankruptcy relief, most file either a Chapter 7 or Chapter 13 petition, depending upon their circumstances. In Chapter 7 bankruptcy, a debtor’s exempt property is protected, and most debts qualify for a discharge, including personal loans and credit card debt. Through the proceeding, a chapter 7 debtor, also obtains a quick financial fresh start which is one of the great aspects of chapter 7 bankruptcy. In Chapter 13 bankruptcy proceedings, a debtor restructures their debt into an affordable monthly payment plan that is typically interest-free. Once the Bankruptcy Court approves their plan, it binds all creditors. In the plan, the debtor pays the claims of their creditors, and depending upon a range of factors, may only pay back a percentage of the debt that is owed. They also only pay claims that are actually filed by the creditors even if additional debt was listed in a petition. In both Chapter 7 and 13 bankruptcy cases, a debtor is protected from their creditors by an automatic stay that prohibits all further debt collection activity. The automatic stay prohibits all debt collection activity and will stop harassing creditor calls, lawsuits, garnishments, and requires creditors to unfreeze restrained bank accounts.

With debt settlement, a debtor hires a company, many of which advertise on tv and on the internet, to negotiate lower payoffs or “settlements” for each account included in the “program.” They may characterize their programs as debt consolidation because they are offering one monthly payment, but they are not offering a debt consolidation loan or providing a credit counseling service. On the contrary, the companies, which often include National Debt Relief, Freedom Debt Relief, JG Wentworth and many others, that are often based outside of New York, will advise the debtor stops paying their bills for the accounts included in the program and to start making monthly payments into their special escrow account. The objective is to build up sufficient funds in the account which can then be used to pay the settlements with creditors, who may be more willing to settle delinquent accounts. This process can often take years to complete and can be devastating to a debtor’s credit. Furthermore, while the negotiation process takes place, the debtor will be deemed delinquent and placed into the debt collection process which can include being barraged by debt collection calls and lawsuits from creditors. Those lawsuits can turn into judgments, which can be used to garnish a debtor’s wage, restrain a bank account and impair the title of a homeowner. Additionally, some debtors confuse debt settlement with debt consolidation, where a debtor takes out a lower interest loan to pay off high interest debt. Both forms of debt relief may lead to lower monthly debt payments every month, but debt settlement leaves the debtor with delinquent accounts in collection and damaged credit.

Many debtors often unnecessarily delay filing for bankruptcy because of the perceived stigma from it, so they consider it a last resort. However, it should often be an option pursued much sooner. “The principal purpose of the Bankruptcy Code is to grant a fresh start to debtors.” Marrama v. Citizens Bank of Mass., 549 U.S. 365, 367, 127 S.Ct. 1105, 166 L.Ed.2d 956 (2007). Often, when a debtor is struggling financially, their best option for debt relief is bankruptcy. It provides quick debt relief, and a debtor is still in a position to rebuild their credit. Unfortunately, thanks to slick and aggressive marketing campaigns, many debtors initially attempt debt settlement. In fact, many clients who retain our office for bankruptcy representation have already tried debt settlement to resolve their financial issues but failed.

Based upon our clients’ experiences and other research, we have found the following:

1. Debt settlement programs did not protect enrollees from creditors or stop collection calls or lawsuits,
2. Debt settlement programs were extremely expensive,
3. The actual savings were insufficient when combined with the program’s costs and actual settlement amount obtained,
4. The program did not advise of the possible negative tax consequence of debt settlement, and
5. Our clients wished they had contacted a bankruptcy attorney earlier. They had seen bankruptcy as their last option when it should have been their first option.

There are a number of things a debtor should know before they even consider hiring a debt settlement company:

First, these debt settlement programs are not government-sponsored or endorsed by the government. Despite marketing themselves as “programs,” the government is not involved in these programs in any capacity. In fact, the industry is facing increased scrutiny of their practices by the Consumer Financial Protection Bureau and various state Attorney General offices.

Second, debt settlement programs do not protect their clients from creditors. They do not legally prevent lawsuits, judgments, garnishments, or bank accounts from being frozen. Bankruptcy, on the other hand, provides an automatic stay that prohibits all debt collection activity and is strictly enforced,

Third, debt settlement programs can take years to complete. Chapter 7 bankruptcy is a relatively quick process and typically is over in a number of months. Chapter 13 bankruptcy can take 36 to 60 months to complete, but it offers protection from all creditors while it is pending.

Fourth, creditors are not required to participate in debt settlement programs, and many opt not to participate. In bankruptcy, all creditors must recognize a bankruptcy filing and comply with federal bankruptcy rules.

Fifth, outstanding debt balances in a debt settlement program can balloon with default interest and late fees while pending in a debt settlement program. Chapter 7 bankruptcy quickly discharges most debt and chapter 13 bankruptcy allows a debtor to pay back most debts interest free. Furthermore, often, not all creditors will file a claim in a chapter 13 bankruptcy case with the short window of time allowed or for other reasons. Any debt included in chapter 13 cases, where a creditor does not properly file a claim would be discharged just like in a chapter 7 case, when the plan is complete.

Sixth, after taking a debt settlement program’s fees and tax consequences into account, these programs often provide almost no to minimal actual savings. Many of these companies charge 20-25% of the outstanding balances as their fee and not based upon what is actually saved. In addition, any debt savings that are forgiven exceeding $600 may result in a 1099-C being issued by the creditors. The IRS views this debt forgiveness as income, and the debtor may be responsible for paying taxes on it. Conversely, there are no negative tax consequences from debt forgiven in a bankruptcy. Additionally, years ago when there was a financial crisis and banks were struggling, debt settlement programs used to obtain better settlement results. Now from what we see, creditors often want 50% or more, even up to 70% of an outstanding balance. This is much higher than years ago.

Finally, who would you rather use to handle your important financial wellbeing and data, a licensed attorney, or an unlicensed sales associate or representative. Having an experienced attorney who is a member of the bar and bound by an ethics code is much preferable to using someone who is not and may misrepresent what their “program” can achieve.

If you are struggling financially and considering debt settlement, you should speak with an experienced bankruptcy attorney. For a free consultation, you can contact the Law Offices of David I. Pankin, P.C. at (888) 529-9600 or through our online contact form. We have over 28 years of experience, helping debtors achieve a fresh financial start!