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Chapter 13 Bankruptcy vs Debt Settlement

debt settlementAt my practices in Brooklyn and Long Island, I have represented thousands of people through financial crisis, and although the individual set of circumstances differ, there are a few common themes.  In fact, I’ve found that when most people are faced with mounting bills and desperately want to get out of debt, they want to pay!  They first start to haphazardly send in minimum payments – maybe a few dollars more – until they come to the realization that their debt is not decreasing and all of their hard earned money is going to interest payments and late fees. Their desperate search for a solution then turns toward a comparison of Chapter 13 bankruptcy and debt settlement companies. There are real differences between debt settlement and Chapter 13 bankruptcy. The trick to learning what is in your best interest is getting a free consultation with a qualified attorney and getting past the myths about bankruptcy and analyzing the two different options.


Nicole R from Suffolk County was dead set against bankruptcy until she got tired of throwing away her money and was driven into my office – Doyaga & Schaefer.  Nicole and her husband had previously filed a Chapter 7 bankruptcy.  After their bankruptcy, they had a child and bought a home.  But when Nicole lost her job as a video editor, their family amassed $70,000 in credit card debt.  Nicole was tough and had lots of great questions.  We discussed all her concerns and she ultimately made the decision to abandon her effort through debt consolidation and file for Chapter 13 bankruptcy.  Below are some of her concerns:

Protect Her Credit Rating

Nicole thought that because debt consolidation was not a matter of public record and bankruptcy was that it was the better path.  But when we dug a little deeper and discussed that her debt to income ratio was terrible.  Any attempt to obtain new credit would be denied because the amount of unpaid debt was overwhelming.  Although debt consolidation doesn’t report a public record, her financial problems were readily discoverable.  To make matters worse, while she was paying her debt consolidation agency hundreds of dollars a month, they were holding the money and causing her accounts to be reported as delinquent.  Chapter 13 bankruptcy ended the constant reporting of negative information and laid the ground work for her credit rating to recover.


Hidden Costs  

When Nicole first contacted me, she took the position debt consolidation was better and she would never file.  I advised her to compare three monthly statement from her debt consolidator and determine how much of her monthly payment was actually going to reduce her debt and call me back.  I then asked her to call and see how much of her “reserve account” would be refunded if she stopped the program.  The next day Nicole called me back and she was shocked.  Almost none of her hundreds of dollars was ever making it to her debt.  The company was charging her all kinds of administrative fees and costs.  In Chapter 13 bankruptcy, there is a manageable upfront fee and then they monthly payments almost all go directly to the debt.  The Chapter 13 trustee disburses the agreed upon monthly payment for an agreed upon time period (either 3 or 5 years) so the end is always in sight.  Nicole discovered she would have been in debt consolidation forever and with Chapter 13 all the fees charged are easy to understand and her money was actually going to solve her problem.


Negative Tax Consequences

When I told Nicole she would receive a 1099 for any forgiven debt and that the IRS considers it income, she almost hit the roof.  Yes, that is right, if a debt consolidator reaches a settlement on a $10,000 obligation for $3,000, the card holder is send a 1099 for $7,000.  For those going down the road of debt consolidation and paying thousands and thousands of dollars, many people only find themselves with an income tax problem.  This isn’t the case in bankruptcy.  The debt is discharged (not forgiven) and therefore there isn’t a tax consequence.

Simplify your debt management.  Debt consolidator promised to serve as Nicole representative between her and her creditors.  They make it seem very simple (remember, they are not lawyers and cannot give legal advice).  They made lots of promises to stay in touch with her creditors and achieve amazing results.  While they collected Nicole’s money (that they are good at) to fund her settlement account her debt was increasing with every penalty and interest charge.  While her debt consolidation company did pay of one creditor, what drove her to call me was when she was sued by a different creditor.  Nicole tried to refer them to her debt consolidator but the creditor refused to be part of their program and started a collection lawsuit.  She called the company only to be told she should consult an attorney for that creditor.  In Chapter 13 bankruptcy, on the other hand, the court makes sure all creditors participate.  Nicole and her husband were protected by the automatic stay against any collection actions.  Even the one collection action that already started had to stop, everything was handled through my office and the courts.  Once her payment plan was confirmed by the court, all Nicole had to do is make the one affordable payment (less than what she was paying) and she would always enjoy the protections of the law.


So it has been some time and Nicole and her husband are almost done with their Chapter 13 payment plan.  All the time they were in bankruptcy, their mortgage payment and car payments were on time.  Those creditors reported positive information to the credit reporting agencies.  Nicole periodically calls me and we laugh about how sure she was that debt consolidation was better than Chapter 13 bankruptcy.  Her husband is now 8 years on the police force in New York City.  She is back to work as a video editor.  And it all started was a phone call.  Take the time to think about how you are spending money on debt.  Sit down with a professional.  My partner and I pride ourselves on looking at your special set of circumstances and finding out the best solution – many times it is Chapter 13 bankruptcy not some fee ridden debt consolidator filled with empty promises.


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