Unsecured debts, such as medical bills and credit card debts, are not directly tied to your assets. Through debt settlement, an unsecured creditor accepts only a portion of the debt you owe as payment for the full balance. Bankruptcy either wipes away your obligation to your unsecured debts or requires you to pay them off via a payment plan. Which solution is best for you, however, depends upon your circumstances.
Applicability
Debt settlement programs only apply to the creditor with which you negotiate the settlement. Not all creditors will agree to accept a settlement in lieu of payment in full. An unsecured debt settlement does not impact your secured assets, such as a mortgage or vehicle loan.
Bankruptcy is all-encompassing. Once you file for bankruptcy, the court notifies all your creditors, both secured and unsecured. Creditors have the option to deny you a settlement, but they cannot deny you bankruptcy's protection nor can they disregard court orders.
Credit Effects
Both debt settlement and bankruptcy have a negative effect on your credit scores. Creditors report your settlement to the credit bureaus, and it appears within your credit history. Not only does settling a delinquent debt for less than you owe look bad to future lenders, it causes the debt to "update" on your credit report. Because your most recent activity has the greatest effect on your credit rating, updating a derogatory entry by settling it brings your credit score down. A record of the settlement can remain on your credit report for up to seven years.
Bankruptcy is one of the worst notations a credit report can have. Each individual's credit score suffers to a different degree after a bankruptcy, depending on the other information the credit report contains. In general, however, a bankruptcy notation is worse for your credit than settling a debt. According to the Fair Credit Reporting Act, the credit bureaus will report your bankruptcy for up to 10 years.
Income Considerations
Your income and savings should help you determine whether debt settlement or bankruptcy is a wiser option. Do not expect your creditors to settle your debts for pennies on the dollar. If a creditor agrees to a settlement, it expects you to pay as much of the debt as possible. Typically, the older the debt, the less your creditor will accept.
Chapter 7 bankruptcy requirements vary by state, but, if you qualify, the court liquidates your assets--paying off as much of your debt as possible--before discharging your liability to your creditors. Chapter 13 bankruptcy requires you to repay your debts, but your payment plan is based on your income. Thus, if you do not have the income necessary to pay what your creditor demands, bankruptcy may be a wiser alternative.
Loss Potential
Unsecured creditors cannot seize your secured assets, but the bankruptcy court can. Whether the bankruptcy court will seize your property depends on your state's exemptions and the type of bankruptcy you file. Consumers who own considerable assets yet only carry unsecured debt stand to lose their secured assets by filing for bankruptcy rather than negotiating a settlement.
Debt settlement also poses a potential for loss. Hiring a third-party company to negotiate your settlement rather than doing so yourself places you at risk, because debt settlement companies often charge high fees without guaranteeing results. If you choose to terminate your agreement, the company can still pursue you for unpaid fees, leaving you another unsecured creditor to deal with.
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