Bankruptcy & Settlement

Bankruptcy and settlement are two solutions for eliminating excessive debt. Both hurt your credit, but bankruptcy is more damaging because it appears in credit reports for a minimum of 10 years. Debt settlement activity is listed for seven years. The Federal Trade Commission (FTC) advises against bankruptcy unless there are no other options, but it recognizes that some people are forced to file because of long-term unemployment, illness or divorce. For others, settlement is a viable alternative, according to the FTC.

Chapter 7 Bankruptcy

BCS Alliance recommends most people file for Chapter 7 over all other forms of bankruptcy. Chapter 7 is notable because it eliminates debt fast -- a key reason it is endorsed by BCS Alliance. Chapter 7 wipes out unsecured debt, such as credit cards, in several months. The disadvantage is that not everyone qualifies. Individual states set income limits for Chapter 7, and most people qualify only if they have low incomes. The low-income limits do allow many people suffering from long-term unemployment -- more than six months -- to qualify in many situations. People often keep most personal property under Chapter 7 through the use of exemptions, which protect the property from liquidation to pay creditors.

Chapter 13 Bankruptcy

Chapter 13 Bankruptcy also provides relief from creditors, but it's a long journey. Chapter 13 requires a payment plan lasting three to five years, with the debtor's household budget closely controlled by the bankruptcy court during that period. The court determines what it considers reasonable living expenses as it helps establish the debtor's monthly budget. Disposable income remaining after living expenses and secured debt obligations are paid is used to pay unsecured creditors through the payment plan. Mortgage and car payments are examples of secured debt; a credit card is an example of unsecured debt.

The Automatic Stay

All forms of bankruptcy include a legal order known as the automatic stay. The stay is the primary reason some people file for bankruptcy because it offers great protection from creditors. A bankruptcy judge enacts the stay after a person files for bankruptcy; and from that point, creditors must end all collection efforts, including credit card lawsuits and bank account garnishments.

Debt Settlement

Debt settlement does not offer the automatic stay but does allow the debtor to control his own debts and assets without involvement by the government. Settlement allows payment of unsecured debts, such as credit cards, for less than the full balance. SmartMoney reports delinquent credit card debt is resolved through settlement for 20 to 70 percent of the balance. The Federal Trade Commission recommends people manage their own settlements to ensure complete control over the process and avoid possible abuses by for-profit debt-settlement firms.