People explore all of their available options before filing bankruptcy. Bankruptcy is not for everyone struggling with debt. Some may benefit from credit counseling, while others may benefit from loans from family members. However, there is one option that I am pretty sure does not work for most people I meet: “debt settlement” companies. In many cases, I have represented people who unsuccessfully tried this option and only ended up losing their money and adding to their stress. A conversation I had today with a prospective client reminded me that these “debt settlement” companies are still lurking out there, and people struggling with debt need to think about these issues before signing on the dotted line.
Settlement is voluntary. No credit card company has to settle. There is no legal requirement to do so. While it might make sense for them to collect 40% of the debt the fact is, they do not have to. They can still continue to collect and still sue. Generally, someone using the services of a reputable non-profit credit counselor will not be subject to collection calls or law suits, and people filing bankruptcy are protected by the automatic stay.
The Credit Report. When a debt is settled, it is as reported as such. Settled is not “paid in full as agreed.” Reported settlements lowers the credit score.
Taxes. Most of these “debt settlement” companies will not tell you this (although it might be buried in the fine print). You are responsible for the taxes on the amount of the debt that has been forgiven. For real. Here’s an example: if you have a $9,000 credit card debt, and you settle it for $5,000, the remaining $4,000 may be considered taxable income. The creditor should and sometimes will issue an IRS Form 1099C. However, what I have seen more often than not is that a 1099C is filed with the IRS, but not received by the consumer. The income is not declared. A few years later, they receive a letter from the IRS informing them that they underreported their income and they now owe the government money in addition to penalties and interest.
The debt/income ratio. No one wants to file bankruptcy, but look at your debt. If you can afford a monthly payment to a debt settlement company, you may be able to afford a payment towards a Chapter 13 plan. While your creditors may not get paid 100%, you get the protections of the automatic stay, the certainty that there is no tax liability on the unpaid/discharged debt, and credit card companies do not have the option of “opting out” of a bankruptcy filing and suing you unless they get permission from the bankruptcy court (which unless certain exceptions apply, they are not going to get). I know it’s bankruptcy, and I know it’s something that you do not want to do, but if your credit report is already bad and/or is going to be made worse…
Look at the fees. I have seen different fee structures, but the most common I have seen is an application fee, the first month or two of payments are fees and do not go towards the payment of debt, and then there is a monthly fee after that. After the first month or two, the consumer realizes the program is not working. They are still getting collection calls and in some cases, getting sued in court.
While there may be situations where “debt settlement” might work, I have never seen it with the people I meet. By the time they come to me, they have made a few months of payments, and are getting sued or have already been sured and now hauled into court for a wage garnishment hearing. By hiring the debt settlement company, they were trying to do what they thought was the “right thing to do” and at the same time avoid bankruptcy. You can imagine then how frustrated they were to end up in bankruptcy anyway.
If you’re contemplating “debt settlement”, don’t be swayed by the hype these “debt settlement” companies offer. Look at the fine print, think about these issues, consider all of your options, and choose the best, most cost effective, and safest way to tackle the debt.
Related posts:
- Yet Another Reason to Avoid the Rip-Off of Debt Settlement
- Debt Settlement: The Devil is in the Details
- Still Considering Debt Settlement?
- Another Reason to Avoid “Debt Settlement”
- IRS Form 1099-C: Discharged Debt is NOT Income
Tags: Bankruptcy, consolidation, consolidation loan, Consumer Scams, Credit and Debt, credit card, Credit Report, debt, debt consolidation, Debt Settlement or Consolidation, settlement
You are talking about unscrupulous debt settlement companies. You did not mention that law firms also offer such services. Law firms have to operate at a higher quality level than these other companes because of the Bar Association of their state. Law firms can also stop collection calls under the FDCPA. One other thing you did not mention when comparing settlement vs bankruptcy is that settlement is not a public record at all. While chapter 13 is a public record for the rest of your life. Also a credit counseling program is made a public record on your credit report while you are in a credit counseling program
Steve,
Law firms do offer such services. However, simply because a law firm offers them does not mean that they are reputable – or for that matter, honest. Andrew Capoccia is a more notorious example of sleazy attorneys. He, along with his partners and others used “debt settlement” companies as a means to rip people off. He operated out of the Andrew F. Capoccia Law Centers (which for a brief time several years ago tried to set up shop here in Massachusetts). He also operated out of another honest-sounding outfit called the Law Centers for Consumer Protection. Presumably he told many people that he could be trusted because he was a lawyer.
As I write this, he has served about 15 months of a 188 month sentence handed down last year by a Vermont Federal Court.
Law firms do not have some special power that stops collection calls. Consumers can do that themselves by properly invoking their rights under the FDCPA (or filing bankruptcy and invoking the automatic stay). It is misleading to suggest otherwise.
I need to address your assertions that “settlement is not a public record at all” and that “chapter 13 is a public record for the rest of your life.”
You state that participation in a non-profit credit counseling program is a part of the “public record” because it appears on the credit report while the consumer participates in a credit counseling program. A consumer’s credit report is not a public record. There are serious penalties for unlawfully obtaining a consumer’s credit report.
A settlement of a debt appears on the credit report as well. Anything other than “paid in full” or “paid as agreed” is considered derogatory. On settled accounts, one might see such entries as “settled/paid in full.” This means that the creditor got less than they bargained for. It’s derogatory. To suggest otherwise is misleading.
True, the bankruptcy docket revealing the filing of a Chapter 13 case does not merely vanish. I imagine that someone seeking a high political office might find themselves needing to explain the circumstances that lead to a bankruptcy filing that was filed many years ago. However, the purpose of bankruptcy is to get through a tough financial time that will eventually pass. I tell my clients this, and it holds true: they may be in a financial storm now, but 5, 10, 20 years from now, they will look back at this difficulty as only a slight ‘bump’ on life’s road.
I would not advise someone not to get married because their divorce might be a public record – and I’m certainly not going to advocate that someone forgo the protections afforded by the US Bankruptcy Code based on concerns that someone might learn of it years later.
Steve – the bottom line is this (and I stress this in the blog entry) – there is no “one size fits all” protective cloak for people struggling with debt. However, people need to make these decisions based on facts – and those facts include their issues, their options, and the “fine print.” They should not make decisions merely on marketing hype, misleading statements, or a sweet sounding sales pitch from a Capoccia-like lawyer.
Thanks for chiming in! Feel free to comment further (and the same goes for everyone else).
–Bill McLeod
Help me to understand: if I owe credit card companies and others in the neighborhood of $30,000, it’s in my best interest to declare bankruptcy and not settle? I have this problem right now, and I disagree. I know my credit score is very poor, because of the collections listed on my credit, but I don’t think a bankruptcy will help me in future. I’m in the position now, where I wasn’t before, to pay some of these past bills, which are now with a debt collecting agencies, and the only thing I want to say on my credit report is “paid in full”. I’m not interested in declaring bankruptcy, just interested in cleaning up my credit and I’m trying to find the best way possible to do that.
An example, I have an old debt with an interest accruded balance of $16,000, but the actual amount owed to the credit card company was $6,900. I spoke with the collections agency, and they are willing to settle with me for $5,000, are not willing to say “paid in full” on my creidt report, and if I’m reading this correctly, I can now be responsible for an extra $11,000 worth of income, which I did not make, but will be declared to the IRS. Correct?
I want to clean up my credit and I want to do it the very best way I can without declaring bankruptcy. Based on this one debt example I have given you, what are your thoughts?
Hi Leah,
Thanks for writing in. First, and most importantly, I cannot determine whether bankruptcy is a good option for you. The only person who can do that is an attorney who can review all of your financial information as well as the facts of your particular situation, and then make a determination of whether a bankruptcy filing will benefit you. If you’re in Massachusetts, I encourage you to call. If you’re not in Massachusetts, please visit the National Association of Consumer Bankrutpcy Attorneys (www.nacba.org) for the name and contact information of a bankruptcy attorney in your area.
Based on the example you provided ($16,000 debt being settled for $5,000), you can be responsible for the $11,000 in income for tax liability purposes. Assuming you’re in a 28% tax bracket, that would amount to $3,080 in additional tax liability on that forgiven amount. So, your $16,000 debt will not cost you only $5,000 (32%) to resolve. It’s going to cost you $8,080 (50.5%).
Settling this debt is not going to “clear up your credit.” It will take care of the debt, but your credit report will have a derogatory remark on it. “Settled” means that the creditor did not get what it had originally bargained for, and you did not live up to the terms of the underlying credit agreement. Essentially, you’re replacing one derogatory remark (which presumably says “In Collection” or “Delinquent”) with another (“Settled”).
Finally, on a side note, assuming you do decide to settle, be sure you get everything in writing. Do not give them bank information or credit card information on the phone. On more than one occassion, clients have ended up in court defending law suits brought by creditors that they believe they had already settled on their own. Attorneys can also assist with settlement of debt, which can include how the creditor reports the underlying debt to the credit bureaus. I urge you to consult with one who can help you.
Good luck!
Bill McLeod
I have a ch 7 discharged off in 2002 because of a divorce. I have since cleaned up my credit and purchased a home which I have had for 3 years. I lost my $80k a year govt job 3 months ago and my sub prime mortgage can not be refinanced because I am unemployed. I stand to lose everything and can’t affort the new mortgage pymts of $2,100. Is my only option bankruptcy again and if so, am I able to declare it again so soon?
Hi Heather,
First, let me say this: as I do not know where you live you should not contrue this information as legal advice. I cannot give legal advice on the site. Please review the Terms and Conditions of the site (the link is to the right). With that said, I can answer your question.
When the bankruptcy laws were changed in 2005, there were important changes to the length of time that must pass before another bankruptcy petition may be filed.
Under Section 727(a)(8) you cannot receive another Chapter 7 discharge if you received a discharge in a case that was commenced within the 8 year period prior to the filing of the petition.
Under Section 1328(f)(1), you cannot get a Chapter 13 discharge if you received your Chapter 7 discharge during the 4 year period preceding your filing a Chapter 13 petition.
I recommend that you speak with local bankruptcy counsel (please feel free to call me if you’re located in Massachusetts). I urge you to do this as soon as possible, especially if you’re already falling behind on monthly payments.
Once an attorney has reviewed things – including the exact dates of filing – then you can get the advice you need.
Also, I am going to be writing a post about this very topic soon. Please check back.
Good luck!
Bill McLeod
Bill I agree with what you said about my comment earlier. There is no one size fits all for peoples debt situations. And you are right there are a number of very bad settlement companies and law firms. But on the other hand there are very good companies and law firms that do good jobs and really do help people out. Unfortunatley across the entire debt relief industry (credit counseling, BK, debt settlement) you have “scam” companies. These people for lack of a better work suck. They dismerit the industry as a whole. Anyway nice blog you have here Bill. I like it and nice action of conversation flow going through here too. Keep up the good work and good luck.
I really need advise on my debt settlement and the fact that I am being sued.
Sharon,
If you need advice, please consult with an attorney. We cannot give legal advice on the website. If you’re local (Massachusetts), please consider completing the contact form (see the link on the right menu, or giving us a call and letting us know a way of contacting you.
If you do not reside in Massachusetts, we cannot offer you assistance. I recommend you contact your local bar association for a referral (check your local phone directory), or visit http://www.nacba.org and click on the “Find a Lawyer” link on the front page.
Good luck!
Bill McLeod
We are presently in a Debt settlement program, it is very stressful,yes, but we have managed to settle with one credit card co. and now we are working with anothe But they still want payment until paid in ful. We have auto deduction to the debt settlement company of $300.00 monthly. Are we still able to file bankruptcy if this does not go well? Now we are getting attorney calls at our place of employment. We did this in lieu of filing bankruptcy. I had breast cancer surgery, 6 months of chemo, then 6 weeks of daily radiation. I missed a lot of work, had numerous medical bills (even with insurance), we fell so far behind it was impossible to catch up. We live in Florida. Thank you…
Teresa,
I am happy to hear you have managed to settle with one credit card company, but it sounds like the Debt settlement program has not helped you with all of your debt issues – which I am sorry to hear about. While I am not an attorney licensed in Florida, and this is not legal advice, I think it is fair for me to assume that if you’re getting calls at work from collectors and/or their attorneys, the program is not working as you originally contemplated.
I don’t know if you can file bankruptcy because I do not know all of the facts of your particular situation – and since your’e in Florida, I cannot advise you what to do (and I wouldn’t do it here on this site). So here’s what I recommend…
Contact a local attorney in your area that concentrates in Consumer Bankruptcy. You can try your local bar association for a referral (there might be a listing in your local phone directory or on line), or you can also point your web browser to the National Association of Consumer Bankruptcy Attorneys, and click on the Attorney Finder located on the right side of the page. And for anyone else reading this, this is the best site that anyone in the US can start the search for a bankruptcy attorney). Don’t delay – you might save yourself a $300 per month auto deduction payment.
Good luck!
Bill McLeod
My husband recently went in on a business that failed. With prior unsecured debt we now face nearly $50K total. We have been researching debt settlement and bankruptcy and feel both are an easy way out but there are consequences to each. The debt settlement company I have been talking with tells me, yes there is no guarantee we won’t be sued but my debt will be paid off in 3 years. From what I have read of other entries on your site we may have it paid (assuming they all would settle) but we would be facing law suits, harassing calls, and other fees, correct? At this point our credit is good in regards to on time payments but is bad in regards to debt to income ratio. We are not late on any payments but struggle every week for necessities because everything is paid on time and most of the time I pay a credit card bill on time but turn around and charge groceries, gas etc. I have contacted my creditors and asked for help but they won’t help me because I do pay on time every month. What is your advice for me?
–Tara
Tara,
First, my response is not legal advice. You should speak with a local consumer protection/ consumer bankruptcy attorney – or you should contact me directly if you’re in Massachusetts.
Paying the credit card bill on time only to use it for groceries and other necessities is only going to catch up with you. If this is what’s going on, then you’re debt is way out of control. Think about this: if you’re only making minimum payments, it’s only a matter of time before your credit limit is reached, and most of your monthly payment is dedicated towards interest.
In terms of your debt amount, I cannot tell if that amount is too high. If you’re combined household income is $50K, then your unsecured debt is probably way too high. If you’re income is $250K, it might not be as unmanageble.
As far as your debt management plan, I think you may have answered your own question. The plan you’re in could work if (1) everyone agrees to settle and (2) no one sues you or charges you other fees and costs.
Bottom line: speak to an attorney NOW.
Good luck,
Bill McLeod
Another Reason to Avoid “Debt Settlement”
I have written about so-called “debt settlement” companies that tout a benefit of paying off your debt quicker and cheaper. In the long run, consumers are left with less money and still at the door of the bankrutpcy court. From…