Clients often ask my advice on whether they should pursue “debt settlement” or “debt relief” in order to avoid bankruptcy. The simple answer to this is: “NO!” Debt settlement rarely achieves the client’s goal of resolving their debt problems. In most cases, debt settlement fails to resolve all debts and leaves the client’s credit rating worse off than before.
To understand why, it is necessary to understand how debt settlement works and how debt settlement companies operate. Debt settlement is essentially the process of negotiating a debt repayment program with every single creditor, one at a time. Debt settlement companies will often appear to make this simple by having the debtor pay them one monthly payment which they then split up amongst all of the creditors, keeping a portion of each monthly payment as a fee. This seems convenient for the debtor: one monthly payment and all their debts are resolved. Unfortunately this almost never works due to problems inherent in the debt settlement process.
One of these problems is what I will politely call the unreliability of the debt settlement industry. If you google: “debt settlement scams” you will understand what I mean. There are probably many debt settlement companies that are sincere and professional, however there are many, many other debt settlement companies that are not. Perhaps more importantly, there is no reliable way for a consumer to determine if the debt settlement company they are dealing with is responsible or not. Hiring a debt settlement company can be a gamble, and a bad bet at that: maybe you hire a scam company that takes your money and does nothing, maybe you hire a reputable company that takes your money and doesn’t accomplish what you thought they would.
Even a responsible debt settlement company will rarely be able to help a debtor. This is because creditors are not required to participate in debt settlement and many will refuse to do so. This means that the debtor will [often unknowingly] only settle some of their debts. Because debt settlement will have the debtor stop paying their debts, all of their creditors will report delinquent payments to the credit bureaus, but only some of them will report settlements. Worse still, because debt settlement occurs over a lengthy period, the debtor will have many negative reports on their credit covering a large period of time.
Bankruptcy will resolve all debts and will only appear on your credit once. Unlike debt settlement, creditors are required by law to participate in bankruptcy and face severe penalties if they refuse. With very few exceptions [see below], bankruptcy will resolve all debts either with a discharge [in a Chapter 7] or a combination of partial payment and discharge [Chapter 13]. The fees for bankruptcies are supervised by the Bankruptcy Courts and are almost always less than debt settlement companies charge. A Chapter 7 bankruptcy is a fairly quick and simple process that does not require any payments from the debtor. A Chapter 13 bankruptcy only requires partial payments of certain types of debt and, unlike with debt settlement, those payments, and their dispersal to creditors is supervised by the Bankruptcy Court and the debtor has certainty that they payments are being applied in the expected manner.
Because bankruptcy provides a debtor with certainty and a complete solution at a lower cost to the debtor than debt settlement, and because bankruptcy generally involves fewer negative reports on the debtor's credit, I never recommend debt settlement as a way of avoiding bankruptcy. Use bankruptcy to solve your debt problems and avoid debt settlement.