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Is Debt Settlement Better Than Bankruptcy for Consumers?

By DebtSettlements.com Staff

Any time a consumer is struggling with debt that cannot be repaid, the consequences to any chosen action are tough. Both bankruptcy and debt settlement carry strong pros and cons that the consumer needs to weigh carefully when making a decision about what to do about insurmountable debt.

Pros and Cons of Debt Settlement
Consumer debt settlement allows for the settlement of debt without the hassle of bankruptcy court. In a debt settlement structure, the creditor agrees to write off some of the debt in return for being paid a lump sum for the remaining amount. The benefit is the ability to “get rid” of the debt load for a fraction of the total amount owed without the hassle and expense of filing for bankruptcy. Debt settlement also has a smaller effect on the credit rating than bankruptcy, although it does pull down a consumer’s score.

That said, debt settlement has some strong cons as well. If the amount of debt written off exceeds limits set by the law, the monetary amount is considered taxable income. This means that you could pay taxes on the balance of your debt. Also, if you enter into debt settlement with the help of a debt settlement company, you will pay fees for that service. Consumer debt settlement can be quite costly. Finally, with debt settlement, the debtor has no court protection against legal action from creditors. Even if the creditor agrees to the debt settlement, the borrower could still get sued.

Pros and Cons of Bankruptcy
Consumer bankruptcy falls into two categories: Chapter 7 bankruptcy and Chapter 13 bankruptcy. In Chapter 7 bankruptcy, much unsecured debt is completely erased at the end of the process. However, assets, like houses or cars, may have to be sold to pay down the debt. Chapter 13 bankruptcy makes it easier to hang onto assets, but it also requires the borrower to pay down more of the debt amount. Chapter 7 bankruptcy may be ideal for some, because it does not carry the tax penalty of debt settlement, while still writing off all or most of the debt load.

That said, most consumers cannot file Chapter 7 because they make too much money. They must file Chapter 13, which requires borrowers to work towards a repayment plan on the debt. The trustee on the bankruptcy case will require strict changes to the borrower’s budget. Many consumers lack the discipline to stick with the repayment plan. After all, if they had this level of discipline, many would not be in debt trouble to begin with. Yet bankruptcy has its pros as well. Under bankruptcy, even Chapter 13 bankruptcy, the debtor has court protection against legal action from creditors. This is not offered with debt settlement.

The Bottom Line
Each individual case will be different, and consumers should seek the advice of a financial expert about their options before making a decision. For some, debt settlement is the most affordable option with the least number of damaging consequences. For others, the court protection offered by bankruptcy is preferred. Just as there are numerous reason that consumers get into debt problems to begin with, there are numerous ways to deal with the situation, including both bankruptcy and debt settlement.

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