You can find a way out of overwhelming debt — but you’ll still face some major drawbacks.
Debts settlement and bankruptcy are sometimes discussed as giant delete buttons for your debt. They can both be helpful and ease the tension in your finances. But neither are free: You’ll have to pay for each service. It’s not a fast process, either. You may spend months or even years paying back what you owe.
However, when you’re looking to tackle your debt once and for all, debt settlement and bankruptcy both offer the opportunity for you to rebuild your personal finances and your life.
6 ways to compare debt settlement and bankruptcy
| Debt settlement | Chapter 7 bankruptcy | Chapter 13 bankruptcy | |
|---|---|---|---|
| Approximate cost | 20% of debt + income taxes | Without lawyer: $335 With lawyer: $835 to $3,835 | Without lawyer: $310 With lawyer: $1,810 to $6,310 |
| Affect on credit | Stays on credit report for 7 years, temporarily lowers score | Stays on credit report for 10 years, temporarily lowers score | Stays on credit report for 7 years, temporarily lowers score |
| Length of process | 2 to 4 years | 3 to 6 months | 3 to 5 years |
| Qualifying debt | At least $7,500 in unsecured debt — no home, auto or student loans | Any debt as long as you pass a “means test” | Secured debts of less than $1,184,20; unsecured debts of less than $394,725 |
| Approximate success rate | 10% | 95% | 55% |
| Can I keep my assets? | Yes | No | Yes |
What’s the difference between debt settlement and bankruptcy?
When you’re unable to pay off your creditors, both options can dig you out of a hole and allow you to start over again — but not without a cost.
The biggest difference? Bankruptcy lawyers are required to prioritize your interests and protect you against unnecessary penalties. Debt settlement companies are not.
Debt settlement
Debt settlement companies negotiate with your creditors to lower the amount you owe in exchange for payment in one fixed sum. This option is generally only available for people with a lot of unsecured debt — debt that isn’t backed by collateral.
Once you enroll your debt in a debt settlement program, you start depositing monthly payments into a trust account with the company. This money is used by the company to cover the cost of settlement and the fee for using its services.
But debt settlement isn’t guaranteed to work. Some creditors refuse to settle debt. And if you stopped making payments on your debt in anticipation of negotiating it down, you could find yourself owing that creditor more than you started with.
Bankruptcy
The most common types of bankruptcies for individuals are Chapter 7 and Chapter 13. Generally, bankruptcy is a legal process that involves filing a petition to a court. With this petition, you state that you’re unable to repay your debts.
With Chapter 7 bankruptcy, your goal is a discharge. This is an order from the court that bars any creditor from attempting to collect on outstanding debts. It essentially wipes the slate clean, but it also exposes you to losing your important assets, including your home.
Chapter 13 bankruptcy wipes out part of your debt. You have to pay off the rest through a repayment plan, typically over three or five years. Unlike Chapter 7, you can keep your assets.
Which costs more?
Debt settlement can cost more than bankruptcy, but it ultimately depends on how much debt you have.
Debt settlement companies typically charge a fee that’s around 20% of your enrolled debt. Legally, they can collect this fee only after they’ve settled your debt. You might also need to pay income taxes on any settled debt, and your debts will continue to accrue interest and late fees while you’re enrolled in a debt settlement program. In the end, you might only save around 10% of what you owe.
When you file for bankruptcy, you might be able to avoid paying for more than the filing fee of $335 for Chapter 7 and $310 for Chapter 13. You may even qualify for a fee waiver if your income is 150% below the poverty line.
The real expense with bankruptcy, however, are the fees you’ll pay for legal services. Getting a lawyer significantly increases your chances of a success bankruptcy process. Chapter 7 legal fees can range from $500 to $3,500. Chapter 13 legal fees typically fall in the range of $1,500 to $6,000.
Compare debt settlement companies
Which damages your credit more?
In most cases, filing for bankruptcy will damage your score much more than debt settlement.
A Chapter 7 bankruptcy stays on your credit report for 10 years. Chapter 13 stays on for seven. Filing for either type can also lower your credit score by 150 to 200 points.
Successfully settled debts are marked as “settled” on your credit report for seven years, but you won’t face as many restrictions during that time period when it comes to borrowing. And your credit score may take a dip that’s just as bad as filing for bankruptcy.
The danger is when debt settlement isn’t successful. If you’ve stopped making payments on your debt in anticipation of a successful settlement, you risk defaulting on your debts if it doesn’t come through. You’ll mar your credit report and might be left with no alternative to bankruptcy. Of course, you can continue paying your creditors throughout the settlement process, but most people don’t due to the expense.
Negotiate a debt settlement by yourself
Look out for debt settlement scams.
In 2010, the US Government Accountability Office published a report uncovering several fraudulent practices by debt settlement companies. The report lead to a government crackdown and the establishment of trade groups like the American Fair Credit Council.
Keep an eye out for several warning signs of a debt settlement company that’s not legit. Any company that guarantees it can settle your debt, asks for upfront fees or advertises a government program that can eliminate your debt for free is bad news.
Which is easier to qualify for?
Debt settlement typically comes with fewer qualification requirements.
Anyone with unsecured debt of $7,500 or more can qualify to enroll in most debt settlement companies, though most don’t operate in all 50 states.
In contrast, you have to have less than $1,184,200 in secured debts and $394,725 in unsecured debts to qualify for Chapter 13 bankruptcy. You also have to be employed.
Qualifying for Chapter 7 bankruptcy is much more complicated: You must meet a laundry list of criteria that proves you don’t and won’t have the funds to pay your debts.
To be eligible for any type of bankruptcy, you’re also required to get credit counseling from an approved agency before filing. And you won’t qualify for bankruptcy if you’ve had a past bankruptcy petition dismissed in the past 180 days.
Which has a higher success rate?
Bankruptcy has a far higher rate of success.
Nearly everyone that qualifies and files for Chapter 7 bankruptcy has their debts discharged, especially those who file with a lawyer.
A little more than half of Chapter 13 bankruptcy cases are successful. This lower percentage is due to clients finding themselves unable to stick to their payment plans. It’s sometimes possible to have your Chapter 13 bankruptcy converted into Chapter 7 if you meet the requirements.
Debt settlement had a success rate of about 10% before the government crackdown on fraudulent debt settlement companies. Government-commissioned reports show that little has changed since.
Bottom line
Debt settlement and bankruptcy are difficult options that you should weigh carefully. Debt relief comes with the highest risk — it only has a 10% success rate on average — and can be a lot more expensive than you might expect.
Chapter 7 bankruptcy is faster with a higher success rate than debt settlement, but it’s more difficult to qualify for and you could lose your assets. Chapter 13 bankruptcy can take the longest, but it doesn’t come with the risks of debt relief. You get to keep your home, car and anything else you have as collateral.
Each option can significantly damage your credit and make it difficult for you to purchase assets and even find employment. Before you pursue either, first make sure you can’t use other means to decrease your debt.
