In today’s economic climate, many consumers are still struggling with the effects of inflation and higher interest rates, making it harder for them to manage their debt. As more people rely on credit cards to bridge the gap in their budgets, debt levels continue to rise. Many are just paying the monthly minimum payments on their credit cards and some are falling behind. While there are several debt relief options available, some have more costs than benefits and are riskier as well. In this article, we will explore three primary options for debt relief: debt settlement, credit counseling, and bankruptcy, to help you understand which route may be best for your financial situation.

Debt Settlement: Negotiating Your Debt Down

Debt settlement is a heavily advertised industry with well-known companies such as Freedom Debt Relief and National Debt Relief. It involves a process in which you hire a company to negotiate with creditors to reduce the total amount of debt owed. Often the companies promote their services as “programs,” but they are not endorsed or sanctioned by the government. The goal is to settle your debts for less than the full amount by negotiating a lump sum settlement. This option is often advertised as a way to help individuals pay off their debts for less money. However, debt settlement has its risks and drawbacks and often provides little saving once fees and tax consequences are taken into account.

Many debt settlement companies charge high fees—often 20-25% of the total debt enrolled in the program. Furthermore, these companies require you to stop paying your creditors, which results in your accounts becoming severely delinquent, leading to collections, lawsuits, and even judgments against you. As your accounts fall further behind, some creditors may be more willing to settle, but the damage to your credit score can be substantial and your debt can balloon with late fees and interest. Additionally, not all creditors are willing to work with debt settlement companies, and many debtors do not complete their “debt settlement programs.” Finally, any forgiven debt could be considered taxable income by the IRS, leading to potential tax liability.

The process of debt settlement can take years, and during this time, you may experience persistent creditor harassment and possibly even have judgments entered against you. While bankruptcy provides an immediate stay from creditors, debt settlement does not. Furthermore, there are no negative tax consequences from bankruptcy.

Credit Counseling: Cost-Savings Through Reduction in Interest

Credit counseling is another option for individuals who are looking to regain control over their finances. A credit counseling agency, usually a non-profit, works with you to create a debt management plan (DMP). The counselor will assess your finances and budget, negotiate lower interest rates with participating credit card companies, and consolidate your monthly payments into a single, hopefully more manageable payment.

While credit counseling can help reduce the interest rate on credit card debt and create a clear path for paying off the debt, it does not reduce the principal amount owed. Unlike debt settlement, credit counseling companies do not negotiate to reduce the total debt. This means you will still need to repay the full balance of your debts, but at a lower cost due to reduced interest rates.

However, there are several drawbacks to credit counseling. First, not all creditors agree to participate in a debt management plan. Second, credit counseling programs typically last between three to five years, during which time the debtor may not have much flexibility in their budget for emergencies. Third, while the program helps with managing credit card debt, it does not typically address other debts, such as personal loans, auto loan deficiencies and medical bills. Credit counseling may work for those who have a stable income and who are able to afford a debt management plan, but for many, it does not offer a solution to their financial problems.

Bankruptcy: A Fresh Financial Start

Bankruptcy is often considered a last resort, but for many individuals who are struggling with overwhelming debt, it may be the best option. There are two primary types of bankruptcy for individuals: Chapter 7 and Chapter 13. Both offer protection from creditors, lawsuits, wage garnishments, frozen bank accounts and foreclosure via an automatic stay upon the filing of the bankruptcy petition with the Bankruptcy Court.

Chapter 7 Bankruptcy is typically the quicker of the two, with most cases lasting a few months. At the end of the case, the dischargeable debts are eliminated (including credit card debt and personal loans), and the debtor receives a fresh start with an opportunity to rebuild credit. One of the primary benefits of Chapter 7 is the speed with which it allows individuals to regain financial freedom. However, depending on their situation, individuals may need to pass an income-based Means Test to qualify for Chapter 7, which assesses whether they have enough disposable income to repay their debts in a Chapter 13 case.

Chapter 13 Bankruptcy is available to individuals who are unable to file Chapter 7. Usually this is due to the fact that a debtor has either too much income for or too many non-exempt assets, or both to file for Chapter 7 Bankruptcy. Chapter 13 Bankruptcy allows the debtor to create a repayment plan, typically with no interest, over a period of five years (although a shorter plan is possible). In their plan, the debtor only pays back debt where creditors file proper and timely claims with the Court. Most creditors only have 70 days from the petition filing date to file a claim.

In a Chapter 13 proceeding, a debtor makes monthly payments to a Bankruptcy Trustee, who once the case is confirmed by the Court, pays the claims of the creditors in the case. Once the plan is completed, the debtor receives a discharge of their debt, including any debt that was listed in the petition, but the creditor failed to file a claim for. Depending on the specific details of the case, there is also the possibility that only a percentage of the debt needs to be repaid, while the remaining debt balances get eliminated upon completion of the plan. In either circumstance, at the end of the plan, the debtor is debt-free and receives a fresh financial start.

Which Option is Right for You?

When choosing between bankruptcy, debt settlement, and credit counseling, it is essential to consider your financial goals, budget, assets, current situation, and long-term plans. Bankruptcy offers a fresh start by eliminating most debts and providing an automatic stay that stops all debt collection, as well as an opportunity to rebuild your credit. Debt settlement can offer debt reduction, but it is expensive and may result in long-term credit damage and tax consequences. Credit counseling helps with credit card debt but does not reduce the total amount of debt, not all creditors participate and it may not be a feasible option from a budget standpoint for everyone.

It is often the case that individuals who initially pursue debt settlement or credit counseling later realize that bankruptcy is a more effective solution. In fact, many of our clients come to us for bankruptcy representation after attempting debt settlement or credit counseling, only to find that they were not provided with the relief they were promised. An experienced bankruptcy attorney can help you understand the best path forward and help you take the first step toward regaining control of your financial future.

Contact the Law Offices of David I. Pankin, P.C.

If you’re struggling with debt and are unsure which debt relief option is right for you, contact the Law Offices of David I. Pankin, P.C. to schedule a free consultation. Our team has over 28 years of experience helping individuals achieve a fresh financial start. You can reach us at (888) 529-9600 or through our online contact form.