Debt Consolidation vs Bankruptcy

With the economic crisis causing financial problems for people across the nation and around the world, more people are looking into various solutions for their hardships. Two popular choices for dealing with mounting debts are debt settlement and bankruptcy filing. Because of the stigma that bankruptcy has received, many people turn to debt settlement to solve their financial problems. On top of that, lenders try to attract debtors with outrageous claims that debt settlements can eliminate debt with low monthly payments over a few years. The truth is, however, that filing for bankruptcy with the help of a bankruptcy lawyer is not as bad as some people think it is, and debt settlement isn't as good either.

Understanding debt settlement

So what is debt settlement anyways? Before you start buying into all of the advertising ploys and marketing schemes of lenders, you should know exactly what they are trying to sell you. In the most basic terms, debt settlement is a type of financial product wherein the debtor pays the lender a settlement amount that is less than the total amount of debt owed. With a good settlement plan, consumers may be able to eliminate their debt with a lump-sum payment of only 60% of what they originally owed the lender. The remaining balance is forgiven by the lender, leaving the consumer debt-free and happy.

The principle behind these straight payment settlement plans is that the lender would rather receive a lump sum payment that is "good enough," instead of having to wait for monthly payments that may never come. On the debtors' side, you get to eliminate a large portion of your debt, just by making a single payment. The financial crisis is working to fuel both sides here, with the lenders in desperate need of profits and debtors in desperate need of debt solutions. Ideally, you would want to pay for the settlement in cash, to ensure that you have good leverage when negotiating the settlement amount, and to speed up the transaction and debt elimination.

Another form of debt settlement is wherein the settlement company promises to eliminate your debt through small monthly payments over an extended period of two to five years. Some of the advertisements out there have settlement companies claiming that they can get rid of your debt for only 10% or 20% of what you actually owe. The truth is, however, some of these debt settlement companies and their schemes are quite fraudulent in nature.

Let's have a look at how it all works. When you get a debt settlement plan, you will be making monthly payments to your settlement company. The company claims that this money will be used for paying off your debts, but first they put the money into a savings account. The settlement company waits as your monthly payments compound in the savings account. Once there is enough money in the account, the company will then try to negotiate a settlement with your creditor at a lower amount than what you originally own. While this is all happening, your account with your creditor is put into a default status, which means that your account is frozen and you no longer have to make payments. Also, the creditor cannot sue you while your account is in default status.

What debt settlement companies don't tell you

Now for the side that the settlement companies don't want you to know about. First off, the first payments that you make usually go straight into the pockets of the settlement company. Instead of using this money to start paying off your creditor, the settlement company takes the money as payment for their "services." The amount that settlement companies charge can equate to 12 monthly payments. In other words, the company is basically stealing from you and not helping you settle your debts - yet.

Another thing that debt settlement companies don't want consumers to know is that your credit score will still suffer from the results of a debt settlement plan. Because your account is put into default status and payments aren't being made to your creditor for years, it reflects badly upon your credit scores and credit report. In fact, the results of a debt settlement may reflect on your credit score just as badly as or even worse than a bankruptcy. To be able to settle your debt at such a low cost, these settlement companies don't make payments to your creditor for years, exploiting the default status, and waiting until the creditor is so fed up that they will settle for a low amount.

Finally, debt settlement companies definitely don't want consumers like you to know that you can actually carry out your own debt settlements without the help and added fees of a settlement company. Financial institutions have become a lot more lenient and patient when dealing and negotiating with their clients about debt. As long as you have a lump sum of money to work with or a regular income, you can definitely work together with your lender to make debt settlements.

The advantages of bankruptcy over debt settlement

What many debtors don't realize is that a bankruptcy can put them in a far better position to make a fresh start, financially. Perhaps the most obvious advantage of filing for bankruptcy is the fact that you won't need a large lump sum of money, which is exactly what settlement companies ask you for. Basically, filing for bankruptcy with the help of bankruptcy lawyers can eliminate your debts all in one go, without you having to make monthly payments or other settlement fees. Because bankruptcies are handled in the federal court, they have the legal power to stop all kinds of credit collection, banish all of the applicable types of debt, and deal with other debt issues. In other words, you won't have to worry about making more monthly payments, which, if left unpaid, can leave you in an even worse financial state than when you first started. Simply put, a badly negotiated or poorly handled debt settlement plan can be even worse than a bankruptcy. With bankruptcy, you have a chance to start brand new, albeit with a negative twist on your credit report. But debt settlements result in the same way anyways, so it's best to go for an option that offers more benefits, and that is filing for bankruptcy.

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