Bankruptcy Has Answers Debt-Settlement Schemes Do Not

Debt-settlement companies are for-profit businesses that offer to negotiate with creditors to reduce the amounts owed by consumers. Debt-settlement companies make money by charging high fees for every settlement achieved and sometimes even charge high fees without obtaining a lowered or forgiven amount owed. According to federal and state officials, debt-settlement companies fail to work in nine out of 10 cases, which means consumers are left to pay high fees in addition to their unresolved debt.

There are number of problematic issues that consumers should be aware of when dealing with debt-settlement companies:

Debt-settlement companies often encourage consumers to default on debts. Since creditors do not usually negotiate with consumers who are current with payments, debt-settlement companies frequently instruct clients to stop making payments, explaining they will negotiate a settlement with the money the client has paid to them. However, when a consumer defaults, the individual faces penalties, higher interest rates and debt collection efforts that can ultimately result in wage garnishment. The consumer's credit score is also harmed.

Debt settlement can quickly make a bad situation worse. When a consumer defaults on debt payments, the overall debt burden can quickly increase. If creditors refuse to settle, the consumer is left in a worse situation than before.

More often than not consumers lose the roll of the dice when following the advice of debt-settlement companies. The debt-settlement industry acknowledges that their services only work for one-third of their clients. The Federal Trade Commission rates the industry's success rate even lower. The FTC and state attorneys general found that less than 10 percent of consumers successfully complete the services offered by debt-settlement companies.

Even those who are successful can suffer a high price. The consumers who find success in debt settlement may confront an unexpected problem: tax liability. Forgiven debt is generally considered to be taxable income, and credit card companies and other creditors may report a debt reduction to the IRS. The IRS will likely consider the forgiven debt as income unless the consumer is considered insolvent.

The problems involved with debt settlement strategies are not relegated to nefarious debt-settlement companies. The entire debt settlement strategy can be viewed as flawed since the standard business practice is to encourage consumers to breach contractual obligations with creditors.

Consumers should be wary of debt-settlement companies that:

  • Require substantial monthly services fees and demand payment of a percentage of what they've supposedly saved the client
  • Make promises that unsecured debts can be paid off for pennies on the dollar
  • Tell the consumer to stop making payments or to stop communicating with your creditors
  • Suggest that there is only a small likelihood that you will be sued by creditors
  • State that they can remove accurate negative information from your credit report

Bankruptcy as one viable option for debt relief

Personal bankruptcy, whether it is Chapter 7 bankruptcy or Chapter 13 bankruptcy, provides consumers a viable debt reduction option and certain legal protections. To begin, bankruptcy offers distressed consumers the benefit of the automatic stay. The automatic stay occurs immediately upon filing and prohibits all collections efforts by creditors, including garnishments, repossessions, utility shut-off and foreclosures. Both forms of personal bankruptcy offer varying forms of property protection through exemptions or repayment plans. Also, both forms of bankruptcy offer the discharge of most unsecured debts, and Chapter 13 provides tools to adjust or eliminate secured debts. Finally, a consumer who files for bankruptcy is considered insolvent and therefore debt forgiven during bankruptcy is not considered income.

If you are overwhelmed by your debt burden, contact an experienced bankruptcy attorney to discuss your options.