June 27, 2017

Repaying debts with Debt Consolidation, Debt Settlement, or Chapter 13

Paying a portion of your debts with Chapter 13 bankruptcy

In nearly 40 years of practicing bankruptcy law, I’ve learned a lot about human nature. One of those things is that the vast majority of people want to pay their debts. Almost invariably, they do not want to file bankruptcy because of the perceived stigma. This is understandable, but it may lead to a decision that in the long run becomes costly and painful.

To meet that desire to make good on credit obligations, two consumer credit schemes have emerged, debt consolidation and debt settlement. Before exploring Chapter 13 bankruptcy, let’s understand how debt consolidation and debt settlement work.

Debt consolidation

Debt consolidation involves having company that performs these services take your money on a monthly basis and either pay it to creditors which participate in the consolidation or pool the money until the sum is large enough to use to fund debt settlements with creditors. It necessarily involves your stopping payments to creditors. If nothing else, it will have a terribly adverse effect on your credit rating. 

Debt settlement

Debt settlement involves having a company that performs these services negotiate with your creditors to accept less than the amount due and usually accept payments over a period of time. Again, you stop your normal payments, and there will be an adverse effect on your credit.

Debt consolidation and debt settlement: who benefits?

Some people benefit from participating in debt consolidation or debt settlement; however, it has been my experience that a large majority who try them do not benefit. Indeed, a number of companies that purportedly offer these services are shams designed to generate money for the providers. Their fees can run as much as 10% of the amount paid in.

The reasons that consolidation and settlement do not generally work are several. The primary reason is that participation by creditors is entirely voluntary. In other words, creditors have to agree; and unless they do, there is nothing that the consolidation or settlement company can do to protect you from creditors. Thus, as to creditors that do not agree, your interest rate will be sky high, collection efforts will continue, the creditor can sue you obtain a judgment and seek to levy bank accounts and seize property.

Even if the consolidation or settlement company is successful in obtaining creditors’ agreement to accept less than what is owed, trouble can loom in the fact that this can give rise to income taxes in the form of “debt forgiveness income.”

Chapter 13 as a court-supervised option to debt consolidation and settlement

Chapter 13 involves a personal reorganization in which your assets are protected while you make payments to creditors through a plan. It is based on Federal law. The Debtor, the person in the Chapter 13 case, proposes the plan.

Payments are based on the level of your income and/or the value of your assets that you wish to protect from creditors. The amount that you owe to creditors is not a consideration, as you are not required to pay any set percentage of your debt.

Creditors have no say in whether the plan is approved. Federal law tells us what the plan must contain; and if it does, the plan will be approved.

Creditors cannot continue collection activities after the case is filed. If they attempt to do so, they have violated Federal law. At the end of the case, any unpaid obligations are discharged, cease to exist, and can never come back to life.

Finally, there are no adverse tax consequences associated with Chapter 13. In other words, Chapter 13 is a guaranteed way of consolidating and settling debt.

Why debt consolidation and debt settlement efforts fail

The reason that a decision to try consolidation or settlement companies can be painful is that in the vast majority of instances it simply does not work. Time goes by. Rather than working toward credit rating health, you are making things worse. Finally, you are paying for the privilege of making things worse. Thus, if you are considering consolidation or settlement, you should carefully consider what kind of commitment are you going to have to make, how long the process is going to take, what is the cost; and above all, how reputable is the company providing the consolidation or settlement services.

If the risk with a consolidation or settlement service is that a year down the road you have not accomplished anything more than spending money for services that do not produce results, you might consider Chapter 13, the path to financial health guaranteed by the government of the United States.

I offer a no-obligation bankruptcy counseling session if you are interested in exploring this and other options for dealing with your debts.