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RESOLVING CONSUMER DEBTS: Negoiate Discounted Settlements with Your Creditors, or File Bankruptcy?

7 years Ago, MarcWites

Credit card debt can easily and insidiously become overwhelming, especially in today’s difficult economy.  Lately, many well-intentioned consumers have seen their debts spiral out of control due to layoffs and depressed real estate values, as well as factors not related to the economy such as unanticipated expenses resulting from the loss of a loved one, the need for medical care, or a disability.

The question of how to resolve such debts is a difficult one.  Should you attempt to negotiate with your creditors, and when necessary litigate with them, in an effort to obtain a settlement that you can afford, or should you file bankruptcy?

For many people, bankruptcy is a last resort. For example, some people wish to avoid the stigma associated with bankruptcy. Others simply feel better settling their debts by paying a more meaningful portion of the amount owed than a creditor would receive in bankruptcy; in bankruptcy, credit card companies and other unsecured creditors often receive a few pennies on the dollar, and sometimes nothing at all. For some, bankruptcy is not an option as it would negatively impact their job or business in an unacceptable manner, or they may have assets which they do not want to sell or lose in a bankruptcy proceeding.

Of course, debt settlement, like bankruptcy or any arrangement that falls short of paying one’s debts as originally agreed, will negatively impact one’s credit.  However, settling your debts, rather than filing bankruptcy, may have less impact on your credit, for a shorter period of time, than bankruptcy, and thus may provide a quicker path rebuilding credit.

The Fair Credit Reporting Act, [15 U.S.C. §§ 1681 et seq.], a federal law, allows a bankruptcy to be reflected on a consumer’s credit report for a longer period of time than most delinquent credit card accounts.  While a bankruptcy may be reported for up to ten years, 15 U.S.C. § 1681(a)(1) (2011), most credit card accounts placed for collection or charged off may be reported for no more than seven years, with certain limited exceptions. See 15 U.S.C. §1681(a)(4) and (b). The seven year period begins to run upon the expiration of the 180-day period beginning on the date the account goes delinquent immediately preceding the collection activity, charge off, or similar action.  15 U.S.C. §1681(c)(1).

When a delinquent account is settled, the consumer’s credit report is typically updated with a notation indicating that the account is settled and that the consumer no longer owes a balance.  If such an update is not made, the consumer may dispute the inaccurate information and the credit reporting bureau must delete the information if it is found to be inaccurate or its accuracy cannot be verified.  15 U.S.C. § 1681i (a)(5)(A)(i) (2011).  Thus, even prior to the time the delinquencies are removed from the credit report, lenders will generally be able to see that the consumer took charge financially by settling the delinquent account(s).  And, according to Experian (one of the three major credit reporting bureaus), the fact that a previously delinquent account has been settled and has a zero balance may help the consumer’s credit score to recover a bit more quickly than if the account remained unpaid.  Ask Experian: Benefits of Paying a Collection Account (November 9, 2011)  (on file with Wites Law Firm).

Further, when a delinquent account is settled the consumer is eliminating outstanding debt.  Since one factor which may negatively impact credit is excessive debt, the elimination of debt is generally an improvement.  Lenders who are considering extending credit will be able to see from the consumer’s credit report that the consumer’s total debt has been reduced.

(Consumers should periodically check their credit reports with the three major credit reporting bureaus, which are Experian, Equifax, and TransUnion.  If anything is being improperly reported, the affected consumer should contact the credit reporting bureau to initiate a dispute.  The credit reporting bureau must comply by removing inaccuracies or face civil liability to the consumer which may include any actual damages sustained, attorney’s fees and court costs, and, when the noncompliance is willful, punitive damages.)

While debt settlement has its advantages, in some cases bankruptcy may be a better option for certain debtors.  For example, when a debtor is faced with multiple lawsuits over credit cards debts and does not have reasonable prospects of being able to negotiate a settlement to pay the debts, bankruptcy may be a solution.  This is because filing bankruptcy results in what is know as an “automatic stay.”  With certain exceptions, the automatic stay stops all collection efforts and halts all lawsuits and proceedings to enforce judgments against the debtor.  This includes, but is not limited to, lawsuits and proceedings relating to personal, unsecured credit card debts.  11 USCS § 362 (2011).

Another advantage of bankruptcy is that the time frame for being discharged of one’s debts may be relatively short.  For example, in an uncomplicated Chapter 7 liquidation, a debtor’s debts could be discharged within a matter of a few months.  However, this will not always be the case and, in contrast, a Chapter 13 adjustment of debts will require monthly payments to be made over time to creditors, and as such, could take several years to complete.  Also, bankruptcy likely will cost far less to complete then negotiating settlements of your debts, which of course must be paid.

In sum, whether debt settlement or bankruptcy is a better choice for resolving overwhelming debt depends upon the circumstances.  Debt settlement and bankruptcy each present their own unique advantages for consumers faced with the prospect of inability to pay their debts.  In deciding which choice is better, consumers should take the time to do some research, and it is always a good idea to consult with an attorney who has experience in dealing with such issues.

Authored by: Attorney David Steinberg

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