Debt Settlement vs Bankruptcy

As an Ohio attorney with more than 15 years of experience in helping clients through bankruptcy, clients often ask me if they should file for bankruptcy or go the debt settlement route. The answer to this question depends on your financial situation.

Chapter 7

Certain income guidelines must be met in order to qualify for Chapter 7. However, if you do qualify for Chapter 7 (which provides for complete relief of debt and is a called a legal discharge) this route is usually the most appealing. If you are researching Chapter 7, you have probably come across the income charts that establish Chapter 7 eligibility. You should know that even if you do not fall into the eligible category as shown on these charts, you still may qualify for Chapter 7 through a means test.  An experienced bankruptcy attorney can determine if you qualify for Chapter 7.

I should mention here that there is a misconception that if you file for Chapter 7 you will lose all your belongings. Ohio law allows for several personal property exemptions under Chapter 7 and unless you have considerable assets, you will probably not be affected.  Contact my office at 614-556-4522 for more information on filing for Chapter 7 bankruptcy in Ohio.

Chapter 13

Chapter 13 allows individuals and families with higher income and assets that may not be fully exempt under Chapter 7 to protect those assets under Chapter 13.  Under a Chapter 13, you may only be required to pay a portion of your unsecured debt depending on your assets and income. It is a court protected repayment plan through a trustee and may last between 3 to 5 years depending on whether or not your income is higher than the average income for your family size.  It is not unusual to pay as low as 10% of your unsecured debt (i.e. credit cards, medical bills etc.) and to be able to re-write vehicle loans that are upside down.  Some second mortgages may even be removed from your deed and paid at the same amount as your credit card debt. Because of the ability for some Chapter 13 filers to modify their vehicle loans and almost wipe out second  mortgages  (not available under Chapter 7), many people that otherwise qualify for Chapter 7 actually wisely elect to file Chapter 13.

Debt Settlement

When I arrange a debt settlement for a client, it is typically for a client who does not qualify for a Chapter 7 and who would be required to pay back more through a Chapter 13 than what he or she would in a debt settlement.  In some debt settlement cases, you may be able to settle your debts for 40%-60% of what you owe.

Debt settlements are not without their drawbacks.  Creditors involved in a debt settlement will usually require you to make a lump-sum payment in order to settle the debt for the 40%-60% mentioned above. In addition, in a debt settlement you may be issued a 1099 for the amount that the creditor did not require that you pay. This is called debt forgiveness and is taxable if your assets exceed your liabilities up to the amount forgiven. For example, if you are issued a 1099 for $20,000 that you saved and your assets exceed liabilities by only $10K, then only $10k is taxable.  Note that if you have a retirement plan this will be counted as an asset in a debt settlement but retirement plans are exempt under bankruptcy.

Conclusion

Many people are surprised to learn that that their credit rating will not be more negatively affected by bankruptcy than by debt settlement. In addition, for most people, bankruptcy may be more financially advantageous than debt settlement. Unfortunately, many of my bankruptcy clients get involved with debt settlement companies before they see me. The debt settlement companies will not discuss bankruptcy with you because they do not understand how it works and if they did understand how it works they would have to explain to you that is in your best interest to file bankruptcy – and not hire them.  If you are considering bankruptcy or debt settlement, a consultation with an attorney experienced in both debt settlement and bankruptcy should help you clear up your questions and concerns and find the right financial solution.

-Mark Jump

For more information on filing bankruptcy in Ohio contact my Columbus, Ohio office at 614.556.4522