Bankruptcy or Debt Consolidation?

You may have seen or heard commercials on the TV or radio touting debt consolidation through one of many for profit companies as a desirable alternative to filing for bankruptcy.  However, what these companies will not tell you, is that there are many advantages to filing bankruptcy compared to using a debt consolidation company that you should be aware of before making a decision:

The Automatic Stay

When you file a bankruptcy case, you are immediately protected from your creditors by what is known as the “automatic stay.”  The automatic stay prohibits your creditors from calling or writing you to demand payment and immediately stops any lawsuits, wages garnishments, or levies on bank accounts or other assets.   Debt collectors know this, and they abide by it.  Debt consolidation companies will offer you no such protection.  While they maybe working to settle your debts for less than you owe, your creditors are free to commence law suits against you, or take any other legal action to enforce their claim, including garnishing wages and levying bank accounts.

Pay Less With Bankruptcy

There are two types of bankruptcy available to consumers; Chapter 7 and Chapter 13.  Chapter 7, or “straight bankruptcy” eliminates most types of debt, including credit cards, medical, bills, pay day loans, and even some taxes, with no payment plan.  Chapter 7 is available to lower income individuals, or individuals with high secured debt payments.   In some cases, usually where an individual’s income disqualifies them from Chapter 7, Chapter 13 is another option where you propose a payment plan to creditors.  This payment plan is based on what you can reasonably afford to pay each month and lasts between 36 and 60 months.   In many Chapter 13 cases, the required payment can total 10% or less of the amount owed, with the difference being discharged at the end of the payment plan term.  Creditors are bound by the plan and generally cannot object simply because they want a bigger payment.

Debt consolidation companies have little bargaining power in dealing with creditors.  If you owe the money, they have the right to all of it, and generally don’t care who else you owe or how much other creditors are demanding of you.  As such, they are unlikely to agree to as little as 10% of the amount owed. Often, debt consolidation companies are unable to get reductions of more than of 30-50% of the balance owed.

Bankruptcy Discharge Has No Income Tax Effect

Under the Internal Revenue Code, and most state revenue codes, the forgiveness or cancellation of a debt is counted, and taxed, as regular income. This means that if a debt consolidation company is able to settle your $10,000 debt for $6,000, the creditor will be sending you and the IRS a Form 1099, and you will have to pay income tax on the $4,000 that was forgiven.  Many people are not even aware of this when they settle their debts and are quite surprised when they receive the tax bill.   When a debt is discharged in a bankruptcy proceeding, it is never counted as income for tax purposes, providing a truly fresh start.

Stop Interest and Late Fees

When you file a bankruptcy case, the interest and penalties stop accruing on your debt. In a Chapter 13 case, the payment plan is based on what you owed on the day you file. As such, the payments you make in Chapter 13 are actually being applied to what you owe, and not to interest and late fees.

While you are in a debt consolidation plan through a private company, normal interest and penalties continue to add up, increasing your debt. Debt consolidation plans can sometimes last several years before claims are finally settled, meaning potentially thousands of dollars of additional debt. If the debt consolidation plan is unsuccessful (and they often are) you may end up in a worse position than when you started. Also, if the debts are ultimately settled, the additional interest and penalties that are wiped out will be counted as taxable income to you, potentially erasing any benefit of the debt consolidation in the first place.

Have An Attorney By Your Side

It is difficult the underestimate the importance of having an experienced advocate by your side when going through a difficult time in life. Most attorneys who practice bankruptcy law, including those at our firm, specialize in bankruptcy law. They know the ins and outs of the law, the right questions to ask you and the answers to your questions. They will assist you in preparing all of the forms, attend court with you and attorneys are governed by strict ethics rules that require them to be a zealous advocate for you as their client. A bankruptcy attorney’s goal is the same as yours, to get you out of debt in as little time and at as little cost to you as possible.

Employees at debt consolidation companies are not required to have any particular skills, training or expertise and they are sparsely regulated. Many times they will not be able to answer your specific questions or give you any type of legal advice. Their job is simple, sign you up, get you to start paying and keep you paying for as long as possible in order to generate revenue for their company. Usually, debt consolidation companies charge you monthly and they want you to stay in their program as long as possible, meaning they have no motivation to get you out of debt.

If you are feeling overwhelmed by debt, please give our office a call for a free consultation at 617-338-9400.