If you have a ton of debt and very little if any means to pay the debts off at some point, probably sooner than later, you’ll need to attack the debt either through negotiating with your creditors for lower balances through debt settlement or to go for a clean break with bankruptcy. Chapter 7 is the most effective way to wipe as much of your debt as possible. Where does debt settlement play in to all of this.
Debt settlement is exactly what it sounds like. You have to much debt but you do have a little bit of money to pay towards them. Typically creditors won’t even consider a debt settlement option for you until you are behind on your payments. Think about it from their perspective. If you are paying them on time every month, they don’t see the problem. If you start falling behind they get the clear message that something is wrong. After several months of not paying them they will really get nervous that they may never see another dime. Now they are more interested in working something out with you so they can at least get some kind of money back for what they lent you. The biggest fear your creditors have is that you are going to file bankruptcy and they will get nothing. In all reality that may be the best route for you. You may be able to settle your debts for 5 cents on the dollar with your creditors and that may sound really cool until tax season comes around. A little, very big deal, that most people don’t consider is that the forgiven debt can be taxable. The IRS consider any debt forgiveness over $600 to be taxable. So, if you have $50,000 in credit card debt and you settle for $2,500 you will have $47,500 in debt forgiveness. If you are in the 25% tax bracket you will now be responsible for paying the IRS $11,875. Ouch!!! That’s less than $50,000 but if you don’t have money it sucks.
Filing for Chapter 7 bankruptcy can eliminate all of your debts. You will typically have to liquidate all of your assets in order pay off as much of your debt as possible before the remaining debts will be forgiven. Therefore, if you have assets that are worth more than the debt that you owe you are better off selling those assets to pay off your debt. However, if you don’t have a lot of assets and you are overwhelmed in debt filing for Chapter 7 may be the best case scenario for you. The main reason being that you will not have any tax consequence for forgiven debt.
Whether you chose debt settlement or bankruptcy your credit score is going to get hammered and they will both stay on your credit report for 7 – 10 years.
In both instances you can start improving your credit score by taking positive actions to alleviate the negative ones from the debt settlement or bankruptcy.
Do yourself a favor and don’t stress too much about any of this. It’s just money. Yes, it’s important but not worth having a heart attack. You’ll make it through.