3 Ways to Deal with Debt You Can’t Afford – Comparing Bankruptcy with Other Relief Options

Consider these three debt relief options

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Some debt dilemmas can be resolved without drastic measures. If you're just a few thousand dollars in debt, scaling back your spending or finding a short-term second job often works. But for catastrophic debt, a serious intervention is needed. Today we compare three ways to deal with unaffordable debt, so you can see what’s best for you.

Bankruptcy and debt settlement are two options designed to reduce or eliminate debt, while the third option, debt management, does not. However, debt management usually has a smaller impact on your credit report. One word of warning: student loans, child support, alimony and very recent tax debts generally cannot be mitigated or eliminated by any of these options.

#1 Debt Settlement

Debt settlement can be accomplished on your own or by using a firm  – although it comes with a cost. Debt settlement occurs when a creditor agrees to settle the debt you own them for a lesser amount. As a rule, debt settlement can’t occur unless you are delinquent on your payments. If you are still making payments, even if it’s difficult for you, a creditor has no motivation to accept a lower amount.

Debt settlement firms ask you to stop paying creditors and instead make payments to them. Once you fall delinquent enough, your settlement firm contacts the creditor and tries to work out a deal, although they charge you a fee for this service. The kicker is that you will generally need a lump sum of money to settle the debt, rather than paying in installments.

The problem with debt settlement is that you will be inundated with collection calls, could be sued by creditors, and if the creditor does write off part of your debt and accepts a lesser amount, they will likely send you a 1099-C which results in the debt forgiven being treated as taxable income by the IRS. That results in more debt. Also, your credit score will take a hit each month you don’t pay.

#2 Debt Management

Debt management gets you on a repayment plan that hopefully involves lower interest rates than you would otherwise pay and may offer relief from fees for late payments or over limits. Credit counseling agencies can set these plans up for you. You typically pay the counseling agency a flat fee each month which they distribute to your creditors according to the plan you've set up.

As part of the plan, your credit card accounts will generally be closed, and you won’t be able to open new accounts until your plan is completed. Debt management is something that you usually can’t set up for yourself, so you’ll have to use an agency. Depending on the agency, you could see a few hundred dollars’ worth of fees to a few thousand dollars’ worth of fees.

In addition to fees, downsides of debt management plans include possible fraud by your counseling agency (only choose a fully accredit agency) and a hit to your credit score when your credit card accounts are closed. Debt management plans won’t help with most non-credit card debt, and one missed payment can get you kicked off of the plan and back into hot water.

#3 Bankruptcy

Chapter 7 bankruptcy will permanently resolve many debts within just a few months. Credit card and medical bills will be wiped out 100%, and tax debts from properly filed tax returns older than two years may also be eligible for discharge. Even if you earn a higher wage than the median income, you may still qualify for this extensive debt relief so long as your debts outweigh your ability to pay.

Chapter 13 bankruptcy is essentially a debt management plan run through the bankruptcy court. You can wipe out a second mortgage if it's unsupported by equity in your home, and you can also get the principal balance and interest rate on a car loan decreased through a cramdown if the loan is a couple of years old and well above market rate. Which chapter of bankruptcy you choose depends on your circumstances.

The downside to bankruptcy is that it will hit your credit score hard. However, if you can’t pay your bills, your credit will take a hit anyway. The upside is that debt discharged in bankruptcy does NOT become taxable income. If you can’t afford to settle your debts or make debt management plan payments, bankruptcy may be your only workable route to debt relief.

Talk to a Reputable Bankruptcy Attorney to Discuss Your Options

Bankruptcy may not be the best fit for your circumstances, and a reputable bankruptcy attorney can tell you if Chapter 7 or Chapter 13 is not a good option. To find out more about North Carolina bankruptcy, contact the Law Offices of John T. Orcutt. Call +1-833-627-0115 now for a free consultation at one of our convenient locations in Raleigh, Durham, Fayetteville, Wilson, Greensboro or Wilmington.