Debt Consolidation and Debt Settlement

Even though this is a blog about bankruptcy issues, we do have some advice about two ways to take care of one’s debts instead of filing for bankruptcy.  They are debt consolidation and debt settlement.

Debt Consolidation

Debt consolidation is where you pay your debts back through a debt consolidation company by sending them a fixed amount of money each month which they then parcel out to your creditors.  What happens is the debt consolidation company gets in touch with your creditors and makes arrangements for them to be paid a certain amount each month.  It is often the case that the debt consolidation company can get a much lower interest rate for each of your accounts, and perhaps a smaller payment each month.

All of your accounts are consolidated in this way, and you have the knowledge that after a certain number of years, your debts will be paid in full.  There are several quite reputable companies in this field that will honestly work for you to consolidate your debts.

Downside of Debt Consolidation

The problem with debt consolidation is that you essentially end up paying ALL of your debts.  They may be paid with a lower interest rate and smaller payments, but they all end up being paid.  And it takes a long time to get them all paid, usually several years.  Of course, the debt consolidation company also adds its fee each month.

We have found that with debt consolidation, the monthly payment may be lower than the total one was paying before the consolidation, but usually the monthly payment is still quite high.  This system works only if you are employed and earning a good income, and is not for those whose credit problems arise from the loss of a job or medical debt.  You still need a good income to make these payments.

If one were to file for bankruptcy, there typically would be no payments to be made, and by the time the debt consolidation payments would have ended, one could easily have restored their credit.  Making that monthly payment is taking a large sum of money out of the family budget.

Debt Settlement

Debt settlement, on the other hand, is a totally different system.  With this method, a monthly payment is made to the debt settlement company, but the money is not immediately paid over to the creditors.  Rather it is put into an account and accumulated.  Meanwhile, you are not paying your bills, and when the calls and letters start coming from the banks, the collection agencies and the lawyers, you refer then to the debt settlement company.

The theory is that after you have not paid for several months, the creditor will be willing to take a reduced amount in full settlement of their debt.  The theory is that you can arrange to pay only half of the outstanding balance, or even less.  As each creditor settles, the idea is that you will have enough money in your account to make the payment that is needed for that settlement.  This method also takes a long time.

Cons of Debt Settlement

The problems with this method are numerous.  First, not all creditors will deal with debt settlement companies, and some will eventually sue you and refuse to settle.  Next, we have been told of fees for this service that are quite high, and have heard from clients who made their payments for several months, then decided to cancel the program and could get none of their money back, despite there having been no settlements.

The biggest surprise to come along with debt settlement is that the forgiven amount is taxable income.  You will receive an IRS Form 1099 for the part you did not have to pay.  Thus, if you have a debt for $10,000 and settle it for $4,000, you will receive a 1099 for $6,000.  This means that your taxable income is now $6,000 higher and you have to pay hundreds of dollars of tax for this forgiven part of the debt.  Few people I have talked to about these programs were ever told that this would happen.

Do Your Research

If you are going to consider either of these options, it is important to do your research.  A wealth of information is available online about these programs, and there is also a wealth of information about all of the companies that offer these services.  Put their names into Google or Bing and see what others have said about the companies before you commit yourself.

About Allan Bloomfield

For over 30 years, my focus in practicing law has been to help people overcome what seems to them to be insurmountable financial difficulties. I have helped thousands of people file both Chapter 7 and Chapter 13 cases, and in most cases, they are able to keep all of their assets, including homes, cars, their retirement accounts and personal property.