Bankruptcy and debt settlement are both options available to debtors who cannot handle their monthly debt payments and need help. Both are serious options: more common options include debt renegotiation and debt consolidation, which either pay off the entire debt or change the debt to make easier to deal with. But sometimes the debtor still cannot make payments or cannot qualify for the necessary changes, so settlement or bankruptcy are the only options. Both have their advantages, but debt settlement is a less drastic option for most situations.
Bankruptcy
A bankruptcy court will examine the debtor's financial information and will usual choose some possessions to sell off and pay back the most serious debts, while completely removing any other debt obligation. Two types of bankruptcy are commonly available to individuals, Chapter 7 and Chapter 13. Chapter 7 bankruptcy is a total bankruptcy with a swift discharge of debt, while Chapter 13 offers more debtor protection but creates a payment plan borrowers must follow.
Settling Debt
Debt settlement only applies to a particular credit card debt. Debtors approach the creditor who holds the card debt and attempts to negotiate to have some of the debt permanently forgiven. The creditor writes this portion of the debt off as a loss and the debtor no longer has to pay it. Creditors typically only agree to settling debts if the debt is old and there is little chance of collecting on it--and if the debtor agrees to pay a portion of it as a lump sum.
Salvaging Credit
When debtors are trying to get rid of impossible debts, a primary consideration should be the effect on credit as a whole. Usually by the time bankruptcy and debt settlement are the only remaining options, most of the damage to credit has already been done. However, bankruptcy will have a further negative effect and stays on credit reports for years. Settling debt usually closes open accounts and can have a beneficial effect on credit, or at least make it easier for debtors to recover.
Costs
Bankruptcy has few associated costs. There is a small fee for filing, and debtors may lose some of their possessions, but they do not incur added expenses that make debt even more difficult to pay off. The same is not true of debt settlement. Not only must debtors provide the necessary lump sum payment, but they also have to pay lender fees and any third-party fees if they use a debt settlement company. This can create additional financial problems.
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