Can serious debt problems be solved through settlement, consolidation, or sometimes even by simply not paying? What are the advantages/disadvantages?
When clients come to see us for a consultation they deserve knowing all their options, including ones other than bankruptcy. Here are three of them.
1. Debt Settlement
If payments on a debt are not paid when due, and the debt falls further and further into default without payment, the creditor may become motivated to settle the debt for substantially less than the amount due under the contract. In general, a debt is more likely to be settled at a deeper discount:
- as the debt gets older, especially as it approaches its statute of limitations
- if the creditor determines that it will likely never be paid because the debtor appears to be long-term judgment-proof—is not expected to have any assets or income that could be tapped for future garnishment or seizure.
- as the risk increases that the debt could be totally written off in bankruptcy
- when the debt is sold to a collection agency, and especially when that happens more than once with a particular debt.
The hoped-for advantage of settling a debt this way is the possibility of avoiding bankruptcy.
But consider these possible disadvantages:
- Interest, late fees, and litigation and other costs can increase the balance on a debt very quickly when a debt is in default. So even if you settle a debt for “pennies on the dollar,” the amount paid may still be quite high because of the skyrocketing amount of the debt.
- The creditor’s write-off of a major part of its debt can sometimes be considered “income” for tax purposes, possibly resulting in you owing a significant amount of unexpected income tax.
- You must have a way to get enough cash to make realistic lump-sum offers to the creditors. If you have to borrow that cash from friends or relatives, you may well simply be digging yourself deeper into debt, AND jeopardizing some of your most important life relationships.
- Hiring a debt negotiation company to do this settlement work is seldom worthwhile. Instead get some unbiased guidance for how to negotiate with your creditors from an attorney, whose legal and ethical obligation is to you alone.
2. Debt consolidation
The benefit of consolidating and/or refinancing your higher-interest unsecured debt into another loan with a lower interest rate and maybe a longer term of payments is that it might lower your monthly payment(s) just enough so that you can keep current. This may particularly make sense with specialized types of debt, such as student loans or maybe older higher-rate mortgages or vehicle loans.
But the potential disadvantages are very serious:
- One of the most damaging mistakes that people make is to incur a secured debt in order to pay off an unsecured debt (for example, paying off credit card debt or medical bills with a home equity line of credit). This changes debt that would likely have been easily written off in bankruptcy into debts that likely can’t be written off without surrendering the collateral.
- As foolish as it may sound, paying down credit cards and similar kinds of credit all too often leads to those sources of credit being run up and maxed out again when cash is tight. This just leaves you deeper in debt.
3. Non-payment of debts
People who are “judgment-proof” may have the alternative of simply not paying their debts. “Judgment-proof” does not mean that a creditor can’t sue and get a judgment against the debtor, but rather that the creditor cannot legally reach any of the debtor’s income or assets to satisfy the judgment. For some people, this can be a sensible short-term, and sometimes even long-term, strategy.
The disadvantages with this:
- Even if you really are “judgment-proof,” some creditors will still sue you, in the hopes that one of these days they will get the money from you somehow. So at the very least you need to be prepared to be sued by knowing exactly how you should react when that happens.
- Being “judgment-proof” at one point does not mean that you will be forever. Either your circumstances could change or the pertinent laws could change, leaving you at risk. Hiring an attorney at every turn to find out if any of your income or assets were in jeopardy could get expensive.
As you weigh these three alternatives to bankruptcy, keep two things in mind, the first about the role of your attorney, and the second about timing.
As mentioned above, when you get advice from an attorney, that attorney has a legal and ethical duty to you and nobody else. That’s applies to your initial consultation as well. In laying out the advantages and disadvantages of your options, he or she can make strong recommendations. And you can certainly ask him or her to make judgment calls about your best course of action based on your goals. But an attorney will not “make you” file bankruptcy or any particular Chapter of bankruptcy. You meet with an attorney so that you can make a well-informed decision, with whatever help you need in making that decision..
In contrast, people who work for a debt consolidation or debt settlement business are generally paid to sell you whatever service they offer.
On the issue of timing, common sense says that you ought to get information and advice about your alternatives early rather than late. Otherwise it could cost you in countless ways. Your choices could be more limited, costing more in money or in not fulfilling your goals as well as you otherwise could. The sooner you get good advice, the more it will help you.