Those with severe debt should weigh the benefits and drawbacks of both debt settlement and bankruptcy. The impact of each is highly dependent on the individual's specific circumstances. Understanding the qualification requirements for settlement and Chapters 7 and 13 bankruptcy will help to assess your particular situation.
Settlement
Debt settlement occurs when you make a single payment for a portion of the amount owed, rather than making multiple payments over time for the full amount owed. Usually the single payment ranges between 20 to 75 percent of your balance. To qualify for debt settlements, you need to appear to be headed for bankruptcy; given the choice between a partial payment or no payment, creditors will take the former. That means you generally must have defaulted on payments to take advantage of settlement. Since a single payment made over 30 days late can knock 110 points off your score, debt settlement may be hugely detrimental to your credit and your future borrowing power. Bankrate writer and bankruptcy lawyer Justin Harelik only recommends settlement for those who have the money handy to make the lump sum payment immediately. He suggests finding out if you qualify for bankruptcy before utilizing debt settlement.
Chapter 13 Bankruptcy
Under Chapter 13 bankruptcy, you may keep certain assets like your car and home; however, you must repay some of your debt over a set period of time. Chapter 13 is a payment plan for those who have a steady income. With this type of bankruptcy, you make payments over a three to five year period of time, after which certain debts are discharged. Since you're repaying at least a portion of your debt, Chapter 13 has less of a negative impact on your credit than Chapter 7. Also, since it's not necessary to default on payments to qualify for Chapter 13 bankruptcy, it's likely to be less harmful than settlement as well.
Chapter 7 Bankruptcy
Chapter 7 is considered a straight bankruptcy, in which your assets are liquidated and certain debts are cleared without payment to the lenders. Both Chapter 7 and Chapter 13 bankruptcies may stay on your credit report for up to 10 years; however, Chapter 7 is viewed more harshly because it signifies to lenders that, for the loans cleared, you didn't repay any of the balance. To qualify for Chapter 7 you must pass a means test to verify that you make less money than your state's median income; however, you do not have to be late on payments.
Considerations
All three options require a certain amount of rebuilding of credit to varying degrees. Before choosing settlement or bankruptcy, it's vital to meet with a credit counselor to formulate a plan of action. Your credit counselor will be able to assess the impact of each option for your specific circumstances. To find a government-approved credit counselor, visit the U.S. Trustee Program website.
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