Many Americans are overwhelmed with debt and confused about their options. Those who are struggling to meet their payment obligations should review the bankruptcy alternatives available to them as well as the protections afforded under the bankruptcy laws.
Bankruptcy Alternatives
In debt consolidation, debtors use a single loan to pay off multiple outstanding loans. While those who qualify can reap the benefit of one lower interest rate, outstanding debts are paid at full price. Not everyone will qualify for a home equity loan or other large loan, especially since the recent economic collapse. This is often a neutral event for credit score purposes.
Some debtors seek credit counseling from a nonprofit organization that offers budgeting assistance and advice, and negotiates on behalf of the debtors for lower fees and interest rates. There is usually a nominal fee for the service, as the nonprofit may be compensated by credit card companies. These debtors should be able to make their monthly payments or they may end up dropping out of the program; by one report, 45 percent of enrollees drop out of credit counseling. Credit counseling may have a slightly adverse effect on credit scores.
Debt settlement involves negotiation of a discount on credit card and other debt; that is, the lender agrees to accept a lump-sum payment (instead of ongoing installments) in exchange for forgiveness of part of the debt. For-profit debt settlement companies frequently instruct the consumer to stop making payments and instead place funds in an account set up by the debt settlement company. The idea is to leverage a better negotiating standpoint than if the consumer were current with payments while accruing funds for a lump sum payment; however, the creditor may sue the debtor in the meantime.
Consumers can engage in their own negotiations but may struggle with the process. Even when successful, debt settlement negatively impacts credit scores and can also subject the debtor to tax consequences for the forgiven portion of his or her debt.
Bankruptcy
In a Chapter 7 or Chapter 13 bankruptcy, debtors have a way to get out from under their debts while at the same time keeping some significant assets. In a Chapter 7 bankruptcy, the debtor is allowed to keep exempt assets, which may include equity in a home or vehicle; non-exempt assets are liquidated, or sold, and the proceeds are used to pay creditors at a discount. At the close of the bankruptcy, the consumer's debts are discharged, with the exception of child support, tax debt, school loans and other non-dischargeable debt.
In a Chapter 13 bankruptcy, in addition to keeping exempt assets, debtors with regular income may reaffirm certain debts to keep other property. After making all the payments as required in the payment plan (typically three to five years), the debts are discharged, with the exceptions as noted above.
Those who are struggling should schedule an appointment with a bankruptcy lawyer to discuss what options may best protect their assets.
