Bankruptcy often trumps debt settlement

At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here’s an explanation for

Dear Bankruptcy Adviser,
We are waiting for a loan modification on our house and a rental home. But we have credit card debt, and we called a debt settlement company. They have started the process, (but) we don’t know which is better — to file bankruptcy or wait for a loan modification and pay the debt settlement company. I just got laid off and our finances are less. My husband is working.
— Alicia

Dear Alicia,
From the beginning, let me say that settling debts does not help your credit score much more than a bankruptcy. The credit reporting model and future creditors will likely consider your credit poor and might not be willing to extend you credit regardless of your best efforts to pay back the debt.

I handle debt settlement for clients only occasionally, but it’s enough to understand when debt settlement is better than bankruptcy. When negotiating debts for a client, I do not take the case if the client does not have enough cash to pay a significant portion of the total debt or if the client will take a long time to get that significant portion together. Meaning, if a client owes $50,000 in credit card or personal loan debt and can come up with about $35,000 right away then I would take the case.

Obviously, there are very few people with that amount of money available. Otherwise, they would not be in debt. But a family member might be willing to help or the person might have equity in their home to refinance, although that’s less likely now, and take cash out.

Most debt settlement companies will have you make a monthly payment to them for a period of three to four years. Typically, the first few months of payments cover the company’s fees. The remaining payments are put into an account that eventually will be used to settle your debts.

The problem is that creditors usually don’t wait three to four years to get paid. Many of my bankruptcy clients hire me after wasting months of payments to a debt settlement company, only to be sued by creditors. The end result is less money in the client’s pocket and more money wasted trying to resolve their situation without bankruptcy.

Yes, I know it is easy to say, that I am the typical self-serving bankruptcy attorney. However, I do handle debt settlements and will continue to handle them in the right scenario. I am not impressed with debt settlement companies that promise low settlement terms, and then accept monthly payments and never settle any accounts.

At the very least, you should know your options prior to attempting to settle your debts and find out whether you qualify for bankruptcy before trying the debt settlement route.