As a Bankruptcy Attorney New Jersey, clients call my office on a weekly basis who have tried to settle their debts and ask me if they should have instead filed for bankruptcy. This is the ultimate question any potential client should ask before they either file for bankruptcy or choose to settle their debts. Let's go over the advantages and disadvantages for each of those two paths.
Settling Your Debts
For those with substantial credit card debts, settling those debts is a valid option. For many clients, the holder of the debt will be willing to settle that debt for a fraction of the principal amount. I have seen companies offer to settle the debt for 25% - 50% of the debt. The rule of thumb I tell clients is like this - the longer you have not paid that debt - the more times it has been sold off to another debt buyer - the more likely you can settle that debt for a fraction of the principal amount.
Clients often ask me though that up until now they have been paying the minimum payments and are not even late yet. In that case, I will advise them that the credit card company will not yet offer you a discounted rate because you are not late on your payments yet. Only when you become delinquent on your payments then will they be open to settling your debt. The longer you do not pay the debt the better discount you will receive. However, if you intentionally do not pay them, then the longer you are delinquent the more your credit score will decrease.
The Debt Settlement Catch
As a New Jersey bankruptcy attorney, I often have to advise clients about the catch the debt settlement programs do not tell you. Yes, you can settle your debts at a discount but you must have cash savings to afford the payoff. The debt holder will not accept a debt settlement from you unless you can payoff the entire discounted amount within a few days. I often find that clients think that they can get a debt discounted and then just pay monthly the discounted amount - this is not possible.
Therefore, unless you have savings to pay off each creditor one by one then debt settlement is not a realistic option. What a lot of the debt settlement companies do is have you pay them a monthly amount each month and they retain a certain percentage to build up savings for you to payoff the debt holders. However, this is something you can do yourself. Often, these debt settlement companies pay themselves first from these monthly amounts so if you cannot afford to make more payments they have already gotten paid and they keep all the money without settling your debts.
Another drawback to debt settlement is that you will be taxed on the debt the credit card company forgives. Let's say for example you settle a $50,000 credit card debt for $25,000. That means that you paid off the credit card company in a lump sum $25,000. Now you no longer owe them any debt, that's great! The IRS, however, will count the other $25,000 that the credit card company forgave as income to you for tax purposes. That means you'll be owing the IRS a percentage of that $25,000 that the credit card company forgave you on the debt depending on your income for that year.
Debt Settlement's Bottom Line
In summary, the advantages to settling your debts versus filing for bankruptcy are you can settle your debts for a fraction of what you owe and you do not need to file for bankruptcy and put your assets at risk, however, you will need to have a lump sum payment to settle your debts, you may have to wait months before you can settle your debts until the debts have aged or you have a lump sum to pay them off, and you will be taxed on the amount the credit card company forgives.
Bankruptcy as an Alternative to Debt Settlement So what can bankruptcy do for you that settling your debts cannot do for you?
Bankruptcy has many advantages over debt settlement. The first advantage is cost. As I mentioned above, if you are going to settle your debts you will need a lump sum payment to pay them off. For example, if you are going to settle a $20,000 debt then you may have to come up with a lump sum of $5,000-$10,000 to pay them off at once. For many clients they cannot come up with that kind of money. By contrast, a chapter 7 bankruptcy in New Jersey costs anywhere from $2,000 - $2,500. This is a one-time flat fee and it eliminates all of your debts in many cases.
When you settle your debts you have to pay off each one, one-by-one. When you file a chapter 7 bankruptcy, you literally wipe out all of your credit card debts. That means whether you have $10,000 of credit card, $50,000 or $100,000 you can wipe out all of that credit card debt for one flat-rate.
Eliminating Your Debts Quickly
When you file for a chapter 7 bankruptcy, you can expect to discharge your debts and get out of bankruptcy in 3-4 months. This is a lot faster than saving up a lump sum and paying off each creditor. This could take a year or more and there is no guarantee that you will even be able to settle your debts during that time period.
Erasing Your Debts Tax Free
When you file for a chapter 7 bankruptcy, all the debt you eliminate is tax-free. As I mentioned previously, when you settle your debts you have to pay income tax on the amount the credit card company forgave. By contrast, you pay no income tax at all on all the debt you eliminate in bankruptcy.
#1 Drawback to Filing for Bankruptcy: Your Assets
The biggest drawback to bankruptcy is that if you have assets they could be put at risk in bankruptcy. That is why you need to speak with a qualified Bankruptcy Attorney New Jersey and find out if any of your assets will be at risk before you file for bankruptcy. In New Jersey for example, you can keep up to $20,000 per person in the equity in your home according to the New Jersey bankruptcy exemptions. Therefore, if you are single and you have let's say $50,000 of equity in your home, then if you were to file for a chapter 7 bankruptcy you may lose your home (although you will receive the $20,000 of equity you can keep in your home). Therefore, before you file for bankruptcy you need to take an accounting of all of your assets such as any business you own, real estate, vehicles, or boats. Then figure out if any of these items have any equity in them. If they do, check your state's bankruptcy exemptions and see if your equity is within the allowed amount. If they are then you can freely file for bankruptcy without your assets being affected. If some of your assets are above the allowed equity amount then you need to speak with a bankruptcy lawyer to find out if there is anything you can do to keep the asset in bankruptcy. Sometimes when clients have assets that will be affected by bankruptcy, I ask them whether they are willing to trade that asset to get rid of all the debt. If the client will discharge let's say $75,000 worth of debt but will lose a car with $6,000 of equity in it - it is clear that the client is still coming out way ahead by filing for bankruptcy.
#2 Drawback to Filing for Bankruptcy: Payments to Insiders
Another drawback you have to check out before you file for bankruptcy is that any payments made to insiders family members or business partners within 1-year of filing for bankruptcy may be undone in bankruptcy. For example, let's say you paid your Mom back $5,000 within the year before you file for bankruptcy. If you file for bankruptcy, then the trustee of your case could sue your Mom to recover the $5,000. Of course, no one wants to involve someone else in their financial troubles so often times a client may delay their filing until after the 1-year period or may choose to file and just warn that family member of the possible result. At the end of the day though the client may still be way ahead even with this result
The answer to the question should you file for bankruptcy in New Jersey is really it depends on your situation. If you have a lump sum of money to pay off your creditors and have assets that you would lose in bankruptcy, then of course you should settle your debts instead of filing for bankruptcy. If your assets would not be touched in bankruptcy then it may make more sense to file a chapter 7 bankruptcy in New Jersey since that would be cheaper and faster than settling your debts. Either way, the most important thing for you to do is to speak with a qualified New Jersey bankruptcy attorney about your case before you either settle your debts or file for bankruptcy. I offer a free phone consultation to help clients with this so I encourage you to call.