Bankruptcy or debt settlement: Which one should you hug?

There are times when you have debts all around you, that forces you to look upto words such as debt settlement, balance transfer, bankruptcy and so on.
This is when, you are confused to take the right step forward, and are pinned down by the dilemma of which debt relief option is better for you!

Your mind is filled with lots of questions like:
(a) Is it better to settle with creditors or file bankruptcy?
(b) What is better bankruptcy or debt settlement?

But today we shall try to put an end to all the confusion circulating debt pay off options. Let’s see what should be your first debt relief option, debt settlement or bankruptcy?

First things first, bankruptcy will hurt you a lot, both socially and financially. In other words you file for bankruptcy when you are financially broke!

On the other hand, settlement gives you options to pay off your debts without liquidating your debts and not having a red mark like bankruptcy in the public records!

How debt settlement works?

This option of debt relief is a bit difficult, but with proper guidance and professional help, you will be able to settle your debts seamlessly!

In debt settlement you negotiate with your creditors to lower your debts. The process becomes tough, because often the creditors want you to pay off the debts in full.

So you can talk to a financial advisor, or take help of a debt settlement company to help you out in negotiating with your creditors!
The debt settlement company will talk to your creditors, and agree to a lump sum payment you will have to do for all your debts.

For your information, no creditors want you to walk away without clearing a decent amount on your debts. Probably this is the reason why sometimes the creditors agree to settle debts on an amount, as low as cents on a dollar!


After both the parties settle to an agreed upon amount, you will be given a time to gather the amount, say 2 years or so. When you have the amount ready, you pay to your creditors, and you become debt free!

But if you take help of a debt settlement company, then your money is stashed away into an ESCROW account, and when the desired amount is reached, the company disburses it to your creditors and you walk away with no debts around you!

Obviously, like any other debt relief options, debt settlement also has its own weak points:

  • You will not be able to settle secured debts. They include a collateral so settlement won’t work over here.
  • The negotiating part becomes difficult because the creditor will never want you to get away that easy. So taking help of a settlement company is favourable. Again the company will charge you fees for their service.
  • The amount you save in a debt settlement will be counted as taxable income. The creditors might send you a 1099C tax notice. Even if they don’t send you the notice, you are still legally bound to pay the taxes!
  • Hurts your credit score. There’s no way you can sail on two boats at the same. Don’t expect to save money on one hand and keeping your credit score intact on the other!

How bankruptcy works?

Usually this is the last resort to debt relief for anyone. No one wants to file a bankruptcy ever in their lifetime.

In general you have 4 chapters for filing a bankruptcy, the chapter 7, chapter 13, chapter 12 and chapter 11!

To give you an overview, chapter 7 is liquidating all of your assets, if by no way you can repay your debts!

Chapter 11 is usually used by corporates and big businesses to repay debts. There’s no debt limit in chapter 11. Even you can file one, but it is costly, critical and may also include liquidation of assets. The process is also called reorganisation!

Chapter 12 is for family farmers and is filed very rarely. It is somewhat similar to chapter 13. In chapter 13 you will be given ample time (typically 5 years) and a suitable plan to pay back your debts. Some may be forgiven like a few unsecured loans, but you can’t run away from secured debts like mortgage or auto loan!

Usually individuals file chapter 7 or chapter 13. But you have to qualify the means test for filing a bankruptcy chapter. The means state will vary from state to state and will depend on your income and the assets you have. So taking help of an attorney is the right decision!

But all I can say is, Chapter 7 is a fast process, where you lose your assets and clear your debts legally. But this stays on your public record for 10 long years.

Whereas chapter 13 is long process and your assets are kept safe, but you need to repay your debts within the time limit set by the court. Chapter 13 stays on the public record for 7 years.

What are the bankruptcy cons?

  • Your social status is highly affected which can bring down questions on your character and trustworthiness.
  • Taxes, student loans, government files or unpaid taxes are not going to be cleared.
  • Hurt your credit score a lot. Way more than debt settlement. Sometimes scores might have a 200 points fall, or even more.
  • You will lose most of your property, sometimes even your home!

Bankruptcy vs debt settlement – What is your option?

  • Settlement, if you have too many of unsecured debts, and don’t want to lose the house or break your social reputation.
  • Bankruptcy, if you have too much of debts and want to go for a fresh start in your life, leaving behind your past in the rearview mirror!

Footnote: No matter whatever option you choose, always take help of an attorney or a financial advisor. This post is meant only for educational purposes and can never determine what’s right or wrong for you, given your current financial situation!