A common question I get asked of my clients with significant credit card debt is whether it would be more appropriate to try and settle with the credit card companies or to even hire a debt settlement company to help them negotiate with creditors. Often I have found that the debt settlement route leaves a lot to be desired. If, for instance, you have $25,000 in credit card and would like to try and settle this debt, typically the creditor will settle for 40% – 60% of the total balance owed — and that is if you can pay it in a lump sum. If you want a payment plan you will not get such a discount (and in all likelihood they will not even offer any type of extended payment plan). So with credit card balances of $25,000, you would need $10,000 to $15,000 in order to settle the debt. Another hurdle arises if you have multiple credit cards. If you have 5 credit cards, and can only get 3 of them to settle, you are still left with the other two to pay in full.
If you don’t feel that you can go it alone in debt settlement, and would like to hire a debt settlement company, it is important to understand how these companies work. In essence debt settlement companies are a way to save the money that is necessary to settle your debts. The debt settlement company will review your debts and estimate what it will take to settle the debt (usually that 40% – 60% number). They will then have you begin submitting a monthly payment to them, which they will then hold until they have sufficient funds to contact your creditors and try and settle the debt.
It is very important for you to understand that during the time it takes for you to accumulate enough money through the debt settle company to settle the debt, that your creditors will continue their collection efforts against you. This means that they will be reporting negative information to the credit bureaus which will harm your credit, they will continue to call you all of the time, and they may even sue you. Routinely I meet with clients who have hired a debt settlement company, begin making monthly payments to this company, and then are shocked when 5 months down the road they get sued by a credit card company.
Also, the debt settlement company does not work for free. Often they will take a percentage of the total amount of debt, usually around 15%. So, using our $25,000 number from above, you would be required to pay $3,750 (15% of $25,000), plus the $10,000 to $15,000 to settle the debt. Additionally, your credit has been substantially harmed during the saving period when you are not making your payments. The debt settlement route will damage your credit and you will be required to pay $13,750 up to $18,750 to settle a $25,000 debt (assuming you can even come up with that money).
In contrast, a Chapter 7 bankruptcy will stop all collection efforts against you the moment your case is filed. The Bankruptcy Code provides for an automatic stay to be issued which stops any lawsuits, repossessions, foreclosures, demand letters, and even telephone calls (yes, the calls will stop!). Further, in most Chapter 7 cases, there is $0 paid to you credit cards. No long drawn out repayment process, and no risk of being sued during your bankruptcy. Finally, the legal fees for filing bankruptcy in Arizona typically are about $2,000 plus another $500 in costs. In comparison, debt settlement will costs you any were from $13,750 to $18,750 while a Chapter 7 bankruptcy will likely run about $2,500, total.
With all this being said, bankruptcy is not right for every situation, and periodically I will see situations where I will recommend settlement. Typically these situations are when there are few creditors, minimal debt, and the client has the money to settle already saved. Bankruptcy will damage your credit, but it is important to realize that bankruptcy is a static event, the further you get away from your filing date the more you will recover.
There is no easy way out a difficult debt situation. However, I have too often seen clients spend a lot of money in hiring debt settlement companies only to see them lose their money, damage their credit, and often get sued in the process.