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When you’ve reached the end of your rope, goes the maxim, tie a knot and hang on. Good advice if you have rope left. If not, and if what little bit of the rope you have left is unraveling as you squeeze, it may be time to grab hold of debt settlement or bankruptcy.

Let’s first acknowledge the slim similarities between debt settlement and bankruptcy: Each is designed to erase or forgive certain types and certain amounts of debt.

Also, at the end of each, your credit score will have absorbed a hammering.

That’s pretty much it. Beyond that, the two processes are remarkably different.

Personal bankruptcy falls, generally, into two types: straight liquidation of assets (Chapter 7) and reorganization (Chapter 13). Both go through the court system where a judge, ultimately, decides the outcome. Both also become part of the public record.

By contrast, debt settlement most often is a private negotiation between someone representing you — an attorney or debt settlement company — and your creditors. Debt settlement is a private transaction.

Once you have qualified for bankruptcy, creditors must stop hounding you for money.

That’s not the case with debt settlement. During the process — usually between 24 and 48 months — collection calls and mail demands continue, along with late and, possibly, over-limit fees continuing to accrue, with no guarantees they’ll reach successful outcomes.

Debt Settlement

Individuals can try negotiating for themselves if they have access to substantial amounts of cash. The cash will be used to pay a substantial portion of their account balances — somewhere in the neighborhood of 40–70 percent.

When cash is scarce, debt settlement candidates turn to outside representatives who usually take the following steps to reach a settlement:

  • Put their clients on a budget
  • Order them to make no more payments on their unsecured (credit card, medical, personal loan, even student loan) debt
  • Order regular deposits to be placed in a dedicated, or escrow, account
  • Use the accumulated money (usually gathered over a 2–4 year period) to make an offer to settle the debt.
  • Pay themselves. Debt settlement company fees could be as much as 20%-25% of your original debt.
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Pros of Debt Settlement

  • If you’re organized and persistent, you can attempt debt settlement on your own. Talk to your creditors; explain your situation; attempt to work out terms. The fees you save can be substantial.
  • If, instead, you require representation and all goes well, you can be clear of your unsecured debt in 24 to 48 months, at a fraction of what you owed — somewhere between 25%-50%.
  • You won’t owe an add-on fee as each debt is settled; that’s already worked into your escrow account deposits.
  • States regulate the debt settlement industry. Know your state’s laws regarding upfront disclosure of fees and services, as well as the risks and benefits.
  • Harsh as it is, debt settlement can mean avoiding bankruptcy, which means, among other things, your plunge into fiscal calamity will not become public record.
  • Debt settlement also causes less damage to your credit report compared to bankruptcy, beginning with how long it remains on your record — seven years, vs. 10 for Chapter 7 bankruptcy.

Debt Settlement Fees

Keeping it simple, if the company eliminates $10,000 in debt and charges a 25% fee, you’ll pay $2,500. Because your rep knows you’re not a reliable credit risk, that fee will come straight from your escrow account (managed by a third party that typically charges fees).

Make certain, before you sign on, you know whether you’ll be charged based on your total debt, or the amount of the debt reduced. The difference could be staggering.

Understand, too, the effect of late payment fees, over-balance charges, and other penalties listed in the fine print of your lending agreement.


Who It’s Best For

That’s certainly true if you have access to substantial sums of money (the do-it-yourself model), or you have the stomach for keeping creditors at bay while you amass the cash to make credible offers.

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Chapter 7 Bankruptcy

You gather your financial records — bank statements, loan documents, pay stubs, credit card statements — and complete a bankruptcy petition, statement of financial affairs, schedules, and other required documents to be filed with the court.

Once approved, your assets — except for certain “exempt” property retained to assist your “fresh start” — are sold by a court-appointed trustee, with the money distributed to creditors who have filed legal claims.

In the end, the debts addressed by your straight/liquidation bankruptcy (exceptions apply) vanish.

Bankruptcy provides considerable relief for anybody overwhelmed with unsustainable levels of debt.

Pros of Chapter 7 Bankruptcy

  • Successfully completed, Chapter 7 is a clean way to achieve precisely what bankruptcy laws were designed to do: give the bankrupt a fresh start.
  • Chapter 7 is fairly quick, usually taking between three and six months to complete.
  • Filers get immediate relief from debt collectors. Calls and other contacts cease.
  • By and large, your debts will be erased.
  • You will not have to pay into a lengthy repayment plan.
  • Your wages will not be garnished.
  • If it’s gone seriously south — like below 600 — your credit score actually will improve substantially in a matter of months.
  • Once your bankruptcy is discharged, you can begin to re-establish credit worthiness by using a secured credit card and/or being added as a user to someone else’s credit account, and sticking to a budget.
  • You can prevent your utilities from being shut off for nonpayment.
  • You can avoid a foreclosure on your mortgaged home, or stop a tax deed sale.
  • Bankruptcy’s “immediate stay” provision means you may be able to prevent your car from being repossessed.

Chapter 7 Fees

Chapter 7 bankruptcy can be pricy. Court fees run $335. The average lawyer’s fee tops $1,100, with some cresting above $3,000. (You want professional representation; filers who represent themselves are far less likely to get the debt relief they seek.)

A successful Chapter 7 filing wipes out most of a consumer’s debts, attorneys usually require payment up front. Otherwise, in most states, their fees may be uncollectible.

Check with the court to see about having fees waived, or arranging a payment plan. Find out whether your state allows making other than upfront payments to your attorney.

Again, if you have any doubt whether personal bankruptcy is right for you, check with a nonprofit credit counseling service first.

When to Consider Chapter 7 Bankruptcy

  • Own little property or other valuables
  • Lack substantial liquid financial assets (stocks, bonds, mutual funds)
  • Have household income that doesn’t exceed the state median for family size
  • Have substantial credit card balances, personal loans, and medical bills, because these will be wiped clean.

Chapter 13 Bankruptcy

Similar to a debt management plan, a Chapter 13 bankrupt pays a monthly sum to a trustee, who, in turn, distributes payments to creditors according to priorities set by the court.

Chapter 13 bankruptcy offers all of the benefits of a debt settlement plan, but you also get tax-free debt forgiveness, all interest and fees stop piling up, collection efforts stop and when you’re finished, you are free of debts.

Pros of Chapter 13 Bankruptcy

  • You get time to pay back your creditors, oftentimes with lower payments than you faced before declaring bankruptcy.
  • Once your plan is complete, creditors who were not repaid in full cannot pressure you into making them whole.
  • Under Chapter 13, a debtor has the length of the plan to catch up on past-due amounts owed on houses, vehicles, or loans secured by collateral. Repossession schemes stop under Chapter 13, and the valuables need not be liquidated as they would in a Chapter 7 filing.
  • Chapter 13 filers also have the life of their plan to pay overdue income taxes and domestic support obligations such as child support and alimony.
  • Chapter 13 protects the debtor’s cosigners on personal loans.
  • In a Chapter 13 case, the debtor may be allowed to pay the bankruptcy attorney’s fee in an installment plan, rather than in advance.
  • Unlike Chapter 7, which limits the frequency of filing, you may file for a Chapter 13 plan repeatedly.
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Chapter 13 Fees

Bankruptcies are legally complicated. Navigating through a Chapter 13 on your own is ill-advised, but an attorney will be costly, somewhere between $2,500 and $6,000. Luckily, the structure of Chapter 13 bankruptcy allows the arrangement of a payment plan.

If you’re particularly squeezed, check with the local bar association about lawyers who do pro bono (free) representation. Also try getting in touch with a nearby legal aid office.


When to Consider Chapter 13 Bankruptcy

In short, if you have above-the-median income, you could meet your obligations if they were reorganized, and there are certain things with which you cannot bear to part — your inherited Rolex or vintage Corvette — but you’re otherwise in way over your head, Chapter 13 is for you.

Debt settlement only works if all the creditors are willing to participate. If not, you might still have to file for bankruptcy, which treats all creditors as equals. The bankruptcy trustee could increase your monthly payments to take care of the earlier settlements. As a result, Chapter 13 monthly payments might be lower than the combined monthly payments from debt settlements.

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Consider Your Options


Kudosware is a tech consulting firm. After 5 years in the industry, we decided to alter direction and now we share our passion by helping others.

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