Should I settle my debts with my creditors or file for bankruptcy?

(See my update on whether to use a debt settlement company or a bankruptcy attorney)

I have blogged about this issue in the past but I am often asked by my clients about the value of debt settlements.  It is a big decision you face when your debts have gotten out of hand so I decided to write about it again.

Settling debts is when you pay a percentage of your total debt owed to each creditor.  These settlements can run from 20% of the balance (if you are real lucky) all the way up to 80%.

You may have heard the ads where the debt settlement companies will say simple things like “don’t file for bankruptcy” or “don’t ruin your credit by filing bankruptcy”  But remember that there are often good reasons for filing bankruptcy if you are eligible to do so.  I believe that there are three main reasons why bankruptcy is better than debt settlement:

1) Credit score– The debt settlement companies emphasize the effect bankruptcy will have on your credit score.  They like to say not to “ruin” your credit.  It is true that your score will decline after you file for bankruptcy.  After your discharge your debts will be reported as “discharged in bankruptcy”.

What the debt settlement companies don’t tell you is that credit scores can be rebuilt.  I have written about this in another blog.  You will get credit card solicitations after you file.  You can use one or two of these to re-build your score.  In fact if you finance anything after the bankruptcy with monthly payments (and you make your payments on time) your credit score will improve.  The same applies if you reaffirm a debt in bankruptcy.

If you do any or all of these things your credit score will then begin to rise and you can re-build your score in two to three years. Your credit is not ruined forever after a bankruptcy.  Telling you that your credit will be ruined forever is just their way of selling you a debt settlement program.

2) You save money– With bankruptcy you don’t have to pay the debts back.  You can discharge these debts in bankruptcy which means that you won’t legally owe them anymore after the bankruptcy is over.  This will amount to a huge savings for you.  It is not unusual for my clients to have $20,000 or $30,000 in debt and some have more than $60,000.  Debtor’s with a business can have $200,000 or more in debt that they can discharge in their bankruptcy.

With a settlement company you will have to pay back a portion of your debt.  In my experience it is possible to get a settlement as low as 20% of the balance.  More often though creditors want 50% to 80% of the balance.  In other words you only get a 20% to 50% discount.  This is a tremendous amount of money to pay to creditors when you could fully get rid of these entire balances if you filed bankruptcy.

Debt settlement companies usually charge more for their services than do bankruptcy attorneys.  This is in addition to your debts.  Then they often charge a percentage of what they save you.  Needless to say this can all be very expensive for you.  A client of mine recently paid a debt settlement company almost $9000 and the debt settlement people did very little for them and they still have to file bankruptcy.

Had they seen a bankruptcy attorney first they could have saved all of this money.

3) You have legal protection– No creditor can attempt to collect a debt discharged in bankruptcy or they will be in violation of federal bankruptcy laws and they will face legal sanctions.  This is not so when a debt settlement company settles your debts.

In a debt settlement situation creditors can and will still sue you.  I have had several clients be sued when they were in the midst of a debt settlement.   The reason why this happens is because of the way they settle debts.  You pay them a set amount every month.  They allow this money to accumulate and then when the amount grows large enough they begin to settle debts one at a time.

But of you have 4 or 5 (or more) creditors then there are a few left for last.  These creditors are receiving no payments or settlements during this period and they get anxious.  Sometimes these restless creditors go ahead and sue.  When they do sue you and you call the settlement companies they will do nothing to help you.  This is my experience in talking with clients who went through this.

Therefore your credit will be better, you will save a lot of money, and you will be legally protected from creditor harassment and lawsuits if you file bankruptcy.

I am a bankruptcy attorney practicing in San Diego.  If you need further help please visit my websites at or  Or call my office for a free consultation at (619) 702-5015.  Call now for a free credit report and analysis!

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