As you may have learned by reading the previous sections, do-it-yourself debt settlement (DS) is far more effective, far safer, and far less expensive than hiring a DS company. If you haven't touched up on the basics of debt settlement, you may want to start at "What is Debt Settlement." There are many "Pro's and Con's of Debt Settlement" and it's certainly better than ignoring your debts, but is it your best option?

A Better Solution

For most people, the best solution is a Chapter 13 bankruptcy. Don't let this term frighten you. A Chapter 13 is much different than a Chapter 7 bankruptcy. Think of a 13 as a government-protected contract that allows you to settle your debts over the next 3-5 years with any future income. Its cost is the court's filing fee; your attorneys fees as allowed by the judge; and the trustee's commission. Chapter 13 plan payments are based on what is available in the debtor's budget after reasonable living expenses.

To qualify for a 13, the debtor must meet the Best Efforts Test. The test ensures that the unsecured creditors receive an amount equal to the debtor's monthly disposable income (found on line 58 of Form B22C) multiplied by 36 (for those with incomes below the state median) or by 60 (for those with incomes above the median). Also, you will have to submit proof that you filed your federal and state income tax returns for the four tax years prior to your bankruptcy filing date. If your gross income is over the state median income, Chapter 13 requires a new method of calculating your payment amount.  The new law requires that the debtor multiply the monthly disposable income by 60 to produce the total amount that must be paid to unsecured creditors under your Chapter 13 bankruptcy.

One of the greatest benefits offered by a Chapter 13 bankruptcy is protection against judgment and foreclosure. While you are in a Chapter 13 bankruptcy, no creditor can sue you and no bank can foreclose on your home, even if the foreclosure proceedings have already begun! Another great aspect to a Chapter 13 is that, at the end of the plan, the dischargeable debt is no longer enforceable. Better still, there are no tax consequences to the cancellation of debt in bankruptcy as there are in debt management programs and debt settlement.

A Chapter 13 has a few disadvantages: you must stay enrolled in your program for at least 3 years; you are not allowed to take on any additional debt without the approval of the trustee; the accounts included in the bankruptcy will remain for 7 years from the date of your last payment.

Either way make a plan, pick your best route, and stick to it. For example, you shouldn't try debt settlement, and if it doesn't work, then file for bankruptcy. The money you will have spent on the credit card debt settlements prior to filing the bankruptcy will be gone forever.

Erasing Your Debt Immediately

In some cases, you may want to apply for a Chapter 7 bankruptcy, even though it doesn't provide protection like a 13 does for the equity in your home. Nevertheless, you must qualify for a Chapter 7 using the means test.

To apply the means test, the courts will look at the debtor's average income for the 6 months prior to filing and compare it to the median income for that state. For example, the median annual income for a single wage-earner in California is $42,012. If the income is below the median, then Chapter 7 remains open as an option. If the income exceeds the median, the remaining parts of the means test will be applied. To view more about the means test, read "What is a Chapter 7 Bankruptcy?"

If you have a significant amount of debt, looking to completely erase all your debts (expect taxes, spousal and child support, and student loans), and don't have any moral issues with bankruptcy you may want to file a Chapter 7. Chapter 7 does not offer a repayment plan; instead the debtor surrenders all non-exempt property to a bankruptcy trustee, who sells it and puts the proceeds towards repaying the debt. You should look to a Chapter 7 as a last resort, especially if your debts are compounding and your income is below the state median.

When Debt Settlement is Appropriate

Trying to settle a substantial amount of debt is not an easy task, not to mention the risk of being sued. DS has many disadvantages compared to a Chapter 13 bankruptcy; however, DS is useful in some situations.

If your debt-to-income (DTI) ratio is lower than 25% ($20,000 income for a household that brings in $80,000 income/year) and you have the available cash to settle all the debt in a timeframe less than a year, you should consider DS. The main advantage here is that you will be able to pay off all your debts in less time than it would take for a Chapter 13 bankruptcy to run its course of 3-5 years.

Even if you have a substantial amount of debt you can successfully use DS, as long as you have the available cash to settle the debts. Since a Chapter 13 prohibits you from taking on any more debt, DS may seem more attractive because, if you can swiftly eliminate the debt, you'll quickly be back on your feet.

What Path Not to Take

Consumer Credit Counseling Services (CCCS) is by far the worst option and has few benefits. Usually, a counselor will suggest a Debt Management Plan, or DMP. Through debt management plans (DMPs), a consumer sends the credit counseling agency a lump sum, which the agency then takes their fees and distributes the rest to the consumer’s creditors. While enrolled in the DMP, the counselor supposedly negotiates with the client's to waive fees and to lower interest rates. Consumers also gain the convenience of making only one payment to the agency rather than having to deal with multiple creditors on their own.

Despite their promises of “debt relief,” these agencies often harm debtors with bad advice, deceptive practices, and excessive fees. Unlike a Chapter 13 bankruptcy, credit counseling will never protect you from any litigations or foreclosures and instead of having a Chapter 13 that ensures all your payments are reported on time, credit counseling lets your accounts report as late!

Terms and Definitions

• Unsecured Creditor - A creditor who tries to collect debt from medical bills, credit cards, personal loans, and bounced checks. With unsecured debts, there is no collateral "attached" to the loan to provide security as repayment. Unsecured loans are typically given to people with good credit. These are the type of debts that a creditor is willing to settle once the debt is delinquent, as they have no way to guarantee they will receive anything from you.
• Secured Creditor - A creditor who finances a debtor with a secured asset (a piece of real property) such as an automobile or a home.  If the debtor can't finish making payments, and defaults on the loan, the asset securing the loan is sold and applied to the default balance. You will not be able to settle these debts, as the creditor will simply accept the collateral property as the "settlement." This is also referred to as repossession.
• Disposable Income - Your monthly income minus your monthly expenses. This is usually the maximum amount you can save each month.

Disclaimer: The information provided in this site is not legal advice. All information is general information, some of which pertains to legal issues involved in the subject matter. Credit Matters Inc. is not a law firm and is not a substitute for an attorney or law firm. Your access to and use of this site is subject to additional terms and conditions.

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