If you’ve been struggling with debt, you may feel pulled in different directions. You’ve probably seen ads for debt settlement companies saying you can settle your debts for a fraction of what you owe. You’ve probably also heard that bankruptcy can offer instant relief. While bankruptcy and debt settlement are both well-known debt relief options, they are very different. Here are some key distinctions you should know about.

Bankruptcy can provide immediate relief. In most Chapter 7 and Chapter 13 bankruptcy cases, an automatic stay takes effect as soon as you file. That’s a court order telling creditors and debt collectors that they have to stop asking you for money. They also have to stop other collection actions. For instance, they can’t sue you, garnish your wages, or repossess your car while the automatic stay is in effect.

Debt settlement involves building up funds over time to negotiate settlements with your creditors. During the time you are saving up and the debt settlement company is communicating with your creditors, there is nothing to stop them from taking aggressive action against you, including filing a debt collection lawsuit.

You’ll typically pay more unsecured debt with debt settlement. Debt settlement companies often advertise that they can cut debt by 50%, or even more. Whether that’s a good deal depends on what type of debt it is. In Chapter 7 bankruptcy, most types of unsecured debt are fully dischargeable. That means the obligation to pay credit card debt, medical bills, payday loans, other personal loans and other unsecured debt can be completely wiped out.

In Chapter 13 bankruptcy, the amount of unsecured debt a person has to pay depends on financial factors, including their disposable income and the amount of secured debt (like mortgage loans and car loans) included in the repayment plan. Many Chapter 13 bankruptcy filers pay none of their unsecured debt, or a very small percentage, with the balance being wiped out at the end of the case.

Bankruptcy and debt settlement have very different timelines. A Chapter 7 bankruptcy case typically wraps up in 4-5 months. Once the petition is filed, most Chapter 7 petitioners have to attend just one quick virtual meeting of creditors, then wait for the clock to run out and their discharge order to arrive.

Both debt settlement and Chapter 13 bankruptcy take longer, but in different ways. In a Chapter 13 case, the debtor submits a repayment plan for court approval. If the plan is approved, the bankruptcy filer makes monthly payments to the bankruptcy trustee for three or five years. With debt settlement, the debtor sends money to the debt settlement company over time. When the company thinks there’s enough money set aside to settle a debt, they’ll reach out to the creditor to negotiate. The creditor may or may not accept the settlement. How long debt settlement takes depends on the amount of debt, the number of creditors, and even how successful the negotiations are. Three to five years is common.

You don’t need creditors to agree to bankruptcy. Bankruptcy is governed by federal law. Creditors have an opportunity to object in specific circumstances, such as if they believe that the bankruptcy petition is fraudulent or that a certain debt shouldn’t be dischargeable. But as long as the filer qualifies for bankruptcy and has fulfilled their obligations, creditors can’t stop the bankruptcy process. We don’t ask their permission, we tell them how it is going to work.

Debt settlement relies on creditor cooperation. Some creditors will accept a lump-sum settlement that’s far less than the outstanding balance, but it’s entirely up to them. The debtor can do everything right and the creditor can simply decline to negotiate and pursue full payment.

Debt settlement companies can’t charge fees up front. That’s important to know if you’re considering debt settlement because some companies have been known to violate that rule. If the company follows the law, you will only pay the debt settlement company after they have settled one or more debts for you.

In contrast, Chapter 7 bankruptcy fees must be paid before filing. That’s because the law states that all of your unsecured debts, including most legal fees, are wiped out when you file (this includes your bankruptcy attorney!!). This is why Borowitz & Clark offers a payment plan. When you retain our office you immediately stop paying the creditors, which frees up funds to pay our fees. Chapter 13 fees work differently because some of the fees can be paid through the personal plan of reorganization.

Debt settlement fees are percentage based. When you file for Chapter 7 or Chapter 13 bankruptcy, your bankruptcy attorney will typically charge a flat fee. A bankruptcy petitioner generally only sees additional fees if there is some sort of add-on to the process, like having to fight a creditor objection in court.

Debt settlement fees are based on a percentage of your debt, and can vary considerably. The percentage is typically 15-25%, but some companies charge more. Fees can be confusing, too. Some companies charge a percentage of the original debt, while others charge a percentage of the settled debt. So, one company charging 20% fees on a $40,000 debt settled for $20,000 might charge $8,000 (20% of $40,000) while another might charge $4,000 (20% of $20,000).

Discounts on settled debt may be taxable. When debt is discharged in bankruptcy, that discharged debt is almost always not taxable. When debt is forgiven, it may or may not be taxable. If you were insolvent at the time the debt was forgiven, it’s typically not taxable. But, creditors may still send you and the IRS a 1099. It will be up to the debtor, and their tax preparer, to determine whether they were insolvent at the time the debt was partially forgiven and file the appropriate forms with the IRS to establish that they don’t owe the tax.

Knowledge is power when it comes to managing debt. Borowitz & Clark has decades of experience helping people in and around Los Angeles reclaim their financial stability. We offer free consultations to make sure you have the information you need to make good decisions for your future. Schedule yours right now. Just call 877-439-9717 or fill out our contact form.