When faced with overwhelming debt, there are different paths that you can take. The two most common routes are bankruptcy and debt settlement – both offer relief, but they differ quite a lot in their approach and impact.
In this post, we’ll compare the two options in order to help you understand the crucial differences.
What is bankruptcy?
Bankruptcy is a legal process that involves discharging debts to effectively wipe the slate clean. It does however have severe consequences, making it best suited as a last resort method.
You can apply for bankruptcy online. An adjudicator will then start the process and your finances and assets will be investigated to see what you are able to pay back. Any debts you cannot pay back are erased.
Pros:
Filing for bankruptcy can help to eliminate both secured and unsecured debts. It puts an immediate halt on all creditor actions including lawsuits, foreclosures, repossessions and collection calls. This court order is known as an ‘automatic stay’.
Cons:
Your assets may be liquidated during a bankruptcy. This could mean losing possessions such as your car or even your house if you are a homeowner. You can also expect severe long-lasting damage to your credit score, preventing you from passing most future credit checks.
What is a debt settlement?
A debt settlement is an informal negotiation process designed to get rid of existing debt. It involves working with a debt settlement specialist to agree to new debt repayment terms – which could include a lower total sum or smaller monthly repayments.
As financial advisors like Alex Kleyner discuss, debt settlements are typically more beneficial to both debtors and creditors, even if creditors receive less money than initially owed: ‘Creditors know that once an account has remained unpaid for that long, the likelihood of collecting the full balance is low. Settlement gives them some way to recover some value without the cost and complexity of legal action, while also giving the person holding that debt the opportunity to honor their obligations in the face of their financial realities.’
Pros:
There is typically no loss of assets required in a debt settlement. Your credit score will likely be harmed, but the impact won’t be as severe or as long-term as bankruptcy. All in all, it is less financially damaging in the long run.
Cons:
A debt settlement is only possible when tackling unsecured debts. There is also no guarantee that it will be successful and you typically have no protection against creditors – meaning that lawsuits or even repossession orders may still continue if already in place. You will also need to be able to pay a lump sum upfront.
Which is the best option for me?
A debt settlement is typically the best option when dealing with a relatively small amount of unsecured debt and is often worth considering before bankruptcy. Make sure that you can pay the upfront lump sum and consider the fact that creditors may continue to call you afterwards.
Bankruptcy is better suited to overwhelming amounts of debt – often when a debt settlement is not an option or has already been tried. It’s also a good option if you need instant legal protection. It can cause serious financial harm afterwards, but less so if you have a steady income and few assets.
