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Consumers overwhelmed with debt have several options, including bankruptcy. But bankruptcy is a major decision. Before choosing bankruptcy, consumers should carefully evaluate other options as well. The most popular alternative to bankruptcy is probably debt settlement or debt consolidation. Understanding these options is critical for any consumer in financial hardship. Our legal team can help you get a better grasp on the following topics:
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There are many different methods of debt settlement. The easiest method is to simply contact creditors, and offer to pay them a cash payment as full settlement of a debt. Typically, the cash payment is 20% to 50% of the full amount of the debt. The actual percent varies, depending upon financial condition of the debtor, the age of the debt, and the aggressiveness of the creditor or collection agency. And there is no guarantee that the creditor will accept a discounted cash payment. Some creditors are very aggressive, and demand high settlements.
For some consumers, a cash payment is simply not feasible. For example, a consumer with $10,000 of credit card debt would typically have to pay a lump sum payment of $2,000 to $5,000 for debt settlement. Some creditors will accept debt settlement on an installment plan, allowing the settlement amount to be paid over a few months.
Consumers do not need to hire an agency or attorney to attempt debt settlement. A consumer facing financial difficulty can simply contact the creditor, and ask about debt settlement options. Although an attorney or agency is not needed to negotiate the settlement, once a settlement is negotiated, it is a good idea to have an attorney review the settlement documents before signing them.
Debt settlement negotiations can be time consuming, frustrating, even nerve-wrecking. Creditors can be rude. They sometimes intimidate consumers by making egregious threats, or harass consumers by calling them at inconvenient times. Because the process can be difficult, some consumers prefer to be represented by an attorney during debt settlement negotiations. The Fuller Law Firm, PC. does represent debtors in debt consolidation.
Before representing consumers in debt settlement, we always discuss the pros and cons of debt consolidation.
The biggest advantage of debt settlement is avoiding bankruptcy. For example, debtors who have substantial assets probably should not file a chapter 7 liquidation. Debtors with substantial debts may not qualify for a chapter 13. And a chapter 11 bankruptcy is too expensive and complicated for most individual consumers.
But if a consumer does qualify for bankruptcy relief, debt settlement usually is not a very good option. That's because debt settlement has several disadvantages, as discussed below.
It is a commonly-held belief that debt settlement is better for credit than bankruptcy. But this is not necessarily true. The debt settlement process usually results in multiple, consecutive negative entries on a consumer's credit report. If a consumer debt-settles with several creditors, the consumer's credit report may reflect multiple, consecutive negative entries for each creditor. The consumer's credit report does not start improving until after the debt settlement is over, which can take from six months to over a year.
By comparison, a chapter 7 bankruptcy is typically finished in three months. Once a bankruptcy discharge is received, no further negative entries are shown, and the consumer's credit report starts improving.
Another disadvantage of debt settlement is its cost. Debt settlement can cost thousands, or even tens of thousands of dollars. By comparison, most bankruptcy cases cost a fraction of this amount. Even a chapter 13 bankruptcy, which requires plan payments, usually costs much less than debt settlement.
Another disadvantage of debt settlement is tax consequences. In most cases, a debt that is forgiven by debt settlement is considered taxable income. For example, if a consumer settles a $10,000 debt by making a cash payment of $3,000, the consumer has to pay taxes on the $7,000 of debt that is forgiven. Usually, creditors issue a 1099 form after debt settlement is completed. A copy of the 1099 form is sent to the IRS, and the consumer is usually obligated to disclose this forgiven debt as income, and pay taxes on it.
A fourth disadvantage of debt settlement is absence of court protection. Even if a consumer is diligently engaged in good-faith debt settlement negotiations, he is generally not protected by any law against collection activities. Creditors can ignore the negotiations, and continue with phone calls, collection activities, lawsuits, wage garnishments, bank levies, and foreclosures. By comparison, as soon as a consumer files for bankruptcy protection, they are automatically protected against almost all collection activities.
Debt consolidation is a variant of debt settlement. Most debt consolidation programs work in the following manner: an agency advises consumers to stop paying their credit card debt. The agency requires the consumer to sign an automatic bank withdrawal authorization. The agency then withdraws a fixed amount from the consumer's bank account every month. The amount withdrawn typically approximates 1% of the total debt being consolidated. So, for a consumer with $30,000 of debt, the agency withdraws $300 per month.
The typical debt consolidation program takes 3 to 4 years, and for the first year, all the monies withdrawn from the consumer's bank account are kept by the agency as "fully earned fees." After the first year, the funds are accumulated, and used to settle the debts. At the end of the third or fourth year, all debts should be settled.
At this time, The Fuller Law Firm, PC does not offer debt consolidation services. We believe debt consolidation offers minimal advantages, and numerous drawbacks, when compared to bankruptcy.
The biggest advantage of debt settlement is avoiding bankruptcy. For example, debtors who have substantial assets probably should not file a chapter 7 liquidation. Debtors with substantial debts may not qualify for a chapter 13. And a chapter 11 bankruptcy is too expensive and complicated for most individual consumers.
But if a consumer does qualify for bankruptcy relief, debt settlement usually is not a very good option. That's because debt settlement has several disadvantages, as discussed below.
Consumers who wish to hire a debt consolidation service should carefully evaluate the service, their reputation, and their history. Ask trusted friends or family members who have used the debt consolidation service, and have successfully completed the debt consolidation program. Do not trust internet testimonials, or testimonials from strangers. See if the debt consolidation company is a subsidiary of a large, reputable financial services institution - a financial services institution you know, not an institution you have never heard from before, that merely has a fancy website.
Also, see if the debt consolidation company is publicly traded. Publicly traded companies must provide quarterly and annual financial reports to the Securities and Exchange Commission. Review those financial reports, or ask a trusted friend with a business background to review those reports, to make sure the company is financially sound.
Finally, see if the debt consolidation agency has a local office. Ask to visit the local office. Ask if the debt consolidation service is a law firm, owned and managed by attorneys licensed in the State they operate. Ask to meet an attorney, not a paralegal. Carefully review the fee agreement. Ask if they are insured or bonded. If you want to pay several hundred dollars a month for the next 3 to 4 years, you want to make sure the company you work with is solid.
Be wary of debt consolidation services that do not have a local office, and whose only presence is a fancy web page and a toll free number. Also, be wary of debt consolidation services that promise that they have "attorneys on staff" who can help you. There is nothing improper about a company that is not a law firm but has attorneys on staff. But if a company is not a law firm owned and operated by licensed attorneys, its staff lawyers can only represent the company. They cannot represent the company's clients. They cannot appear in court on your behalf. They cannot even send a legal letter on your behalf.
The biggest disadvantage of debt consolidation is fraud. Any internet search of "debt consolidation fraud" or "debt consolidation scam" will yield thousands of hits. There are numerous debt consolidation firms that take advantage of honest and responsible consumers who prefer to make partial payment on their debts, rather than walk away from the debt.
The unfortunate reality is that debt consolidation is not a well-regulated industry. The nature of the industry is such that it attracts unscrupulous businesspeople. It is not uncommon for consumers to pay hundreds, or even thousands, of dollars per month to a debt consolidation service, for 3 to 4 years, only to find out that the debt consolidation service filed for bankruptcy, or simply disappeared.
Just as in debt settlement, a major disadvantage of debt consolidation is lack of court protection. Consumers that hire debt consolidation agencies are generally not protected by any law. Many debt consolidation agencies make promises such as sending "cease and desist" letters to creditors. But in fact, the consumer has very little protection while in a 3 or 4 year debt consolidation program. Often, they continue to get harassing phone calls, harassing letters, lawsuits, wage garnishments and bank levies.
Many debt consolidation agencies have devised a method to try to protect their clients from harassment and collection. They obtain power of attorney from consumers and give the creditors a new address and phone number for the consumer. The consumer is given a false sense of security, because the harassing phone calls and collection letters stop. But the reality is, most creditors do not want to wait 3 to 4 years to get paid at a discount. Many will file lawsuits against the consumer, and start wage garnishments and bank levies. If the creditor was given an incorrect address for the consumer, the consumer may not become aware of the lawsuit until after his wages are garnished or his bank account is levied!
As with debt settlement, the other disadvantages of debt consolidation are tax liability and cost. A chapter 7 bankruptcy is faster, and costs a fraction of a debt consolidation. Even a chapter 13 usually costs much less than debt consolidation.
There is a common myth that in a chapter 13, consumers have to pay back all of their debts. This is far from the truth. The reality is, if certain criteria are met, consumers who file for chapter 13 can wipe out their credit card debts without paying them anything. This is commonly known as a "zero percent plan" because credit cards and general unsecured creditors get wiped out and receive nothing. Over half of the consumers who file chapter 13 at The Fuller Law Firm, PC, qualify for a zero percent plan.
In fact, many consumers in chapter 13 bankruptcy propose a zero percent plan to wipe out their credit card debts completely, and also use the chapter 13 process to reduce the interest or principal on their car loans, pay taxes that cannot be wiped out, wipe out their second mortgage, or catch up on their mortgage delinquency. Generally, when the chapter 13 plan is finished, debtors face no tax consequences for the forgiven debt. And while they are in bankruptcy protection, they enjoy broad protection against all collection activity.
In comparison, consumers who use the debt consolidation program typically end up paying 36% to 48% towards their unsecured debt. While they are in debt consolidation, they have to deal with all manners of collection activity. And when the debt consolidation is over, they usually have to pay taxes on the 54% to 42% of the debt that is forgiven.
For these reasons, The Fuller Law Firm, PC, does not believe debt consolidation is advantageous to consumers, and does not offer this service. We do offer debt settlement, for specific accounts, on a case-by-case basis.
Please call us for a free initial consultation for further review. Please note that our firm does not give tax advice, and we recommend that consumers consult with a Certified Public Accountant or a tax attorney for further tax information.
By Sam TaherianAllow Attorney Sam Taherian to work with you from start to finish on your debt consolidation or settlement arrangement. Preparing positive financial solutions for clients throughout San Jose, Salinas, and Oakland, there is no case too complicated for him to handle. Contact The Fuller Law Firm, PC to learn more and receive a free consultation.