I often have clients that come through our office asking about the option of debt settlement or debt consolidation to avoid filing a bankruptcy. While the intent is noble, there can be many pitfalls that you are not aware of when trying to either negotiate down your debt, or alternatively, contract with a debt consolidation company to remedy your debt.
Let me cut right to the chase in discussing the potential problems with each of these “solutions”.
This basically means that you are going to contact the creditor to whom you owe money, and try to pay them a lower amount than you actually owe. ie. if you owe American Express $10,000, you will call them and try to see if they’ll accept $5,000 to settle the entire amount. In some cases, this is a great idea if you can come to terms, however there are a few things you may not realize before you jump into this.
1. When you settle a debt, the creditor usually wants a lump-sum payment immediately. Were you excited that you negotiated American Express down to only $5,000 and cut your debt in half? Slow down cowboy. This doesn’t mean you can now make minimum card payments on $5,000 going forward. American Express will want their money NOW. All at once. And if you’re lucky, perhaps they’ll let you pay in a few installments. If you don’t pay, deal is off.
2. Now that the economy is doing much better, creditors are not willing to negotiate their debts down as much as they did back in 2008 or 2009. There was a time not so long ago when you could sometimes get away with settling your debt for only 10 cents on the dollar. Creditors were desperate to just get anything from you versus getting a big fat ZERO if you were to file bankruptcy. With people back at work and people’s property values no longer underwater, creditors will rarely cut you much of a deal. My American Express example is hard to even find as these days they wouldn’t take 50% of their debt. Depending on your situation – maybe you could get them to reduce your debt by 10% or 20%. Otherwise they are more than happy to sue you.
3. The credit can issue you a 1099 for the amount of debt they forgive. Therefore if you take a $10,000 credit card debt, and settle it for $4,000 – the credit card company may issue you a 1099 for $6,000 of imputed income. The problem with this? Now you’ll have a taxable obligation on the $6,000 and remember – (most) taxes are not dischargeable in a bankruptcy! This is a larger problem for people who negotiate down larger amounts of debt since it can create a significant tax obligation to you that you would have never had had you filed a bankruptcy.
There are two types of Debt Consolidation that we see. The first one is where you take out one loan from one institution to pay off your debts. This simplifies things because now you’re just paying off one lender instead of 20 different credit cards. A simple example would be taking a loan of $20,000 from Logix Credit Union to pay off your 10 credit cards totaling $20,000. Now you simply make one payment every month to Logix to pay back the loan. This is a good option in my opinion, if you can get a good interest rate.
The other type of Debt Consolidation occurs with rip-off artists aka Debt Consolidation Programs. These companies claim that they will bundle up your debt and negotiate your debt down with the creditors. In return, you pay the Debt Consolidation company one small monthly payment, and each month they in turn will distribute it to your creditors – kind of like how a Chapter 13 would work. Here are the problems with them:
1. Most of these companies are complete scams. They will take your payments and hardly turn over any of the money to your real creditors. Next thing you know, you’re embroiled in a fight with the same company that you thought would help you.
2. Creditors can still sell off or transfer your debt and pursue collection activity against you. Yes, that means they can still sue you even if you’re in some sort of debt consolidation program with a third party.
3. Generally these consolidation companies give terrible advice. They will tell you to stop making all of your credit card payments for a few months. You do realize once you do that it will hurt your credit even more. Contrary to popular belief, filing a bankruptcy in many cases actually improves your score!
So there you go folks. Of course, you should do everything you can do avoid a bankruptcy, but in my experience, actually filing a chapter 7 has been much better for my clients than these other avenues. Over the last eight years many of my clients have met with me, tried all sorts of debt settlement and spent thousand of dollars, only to find themselves back at my office a year later, in the same predicament.
If you’re thinking of filing bankruptcy or have any questions, don’t hesitate to reach out and ask! Call our main line at 818-293-5291 or send us an email at firstname.lastname@example.org