As a Bankruptcy attorney, sometimes we see everything through our limited lenses, and of course, when it comes to debt, since our tool is a hammer, every problem resembles a nail.
But the truth is that you always have non-bankruptcy options to settle debt, but most people are often intimidated about trying them.
First, you need to keep in mind that when a qualified Bankruptcy attorney is evaluating your situation, they are looking at the big picture. By that I mean, they are looking at all of your debt, not just the creditors that are bothering you at the moment. We also analyze your income and expenses to see if non-Bankruptcy options are actually feasible. It is not uncommon for someone to spend thousands of dollars clearing up debt, only to hit a roadblock with one or two large creditors and find that they have to still file for Bankruptcy.
But let's say that Bankruptcy really isn't a good option for you. What about debt settlement? How do you go about doing it? Is it even a good idea? Let's handle the first question here, and I'll tackle the second question in my next blog post.
Is debt settlement a good idea? Of course, it is. Anytime you can eliminate debt that is a good thing. The problem comes into play in the details.
At the outset, (and you have heard this a million times), be wary of scams. Scam artists have become very elaborate and sophisticated. In one recent case, I had a client whose home was going into foreclosure. They came to see me about a Bankruptcy to stop the foreclosure and I laid out their options. Then out the blue, they got a very sophisticated packet of material that looks like it came from their mortgage company. The letterhead looked right, and all of their information seemed correct and it offered them the option of paying three installments of $3,000 each to stop the foreclosure. They did not consult with me, and decided to take the offer instead of filing for Ch. 13 Bankruptcy. I was unaware of the offer and I assumed that they had made other arrangements rather than hiring me. A few months later they called me and asked to see me at my office. When they arrived, they asked me why they received a notice that their home had been foreclosed. They showed me the paperwork that they sent to the bank and their proof of payment. I called the bank and they said that they had never sent any sort of packet to these people and that the home had foreclosed properly the week before. Unfortunately, I had to inform these nice people that they had been duped.
So, make absolutely sure that you are dealing with the right party. Next, you need to keep in mind that your account may be handled by multiple departments within the same organization, or worse yet, your debt might be being bounced around to various debt collection agencies. You need to make sure that you are dealing with the right party, or they will simply take your money, apply it to the balance, and keep collecting on the remaining balance.
So, let's say that you have made absolutely sure that you are not being scammed, and you are dealing with the right party who is responsible for your account. Now what?
Before you embark on a debt settlement plan, you need to look at ALL of your debt. Sometimes one or two creditors seem to be hounding you and you feel like just getting rid of them will solve your problems. Instead, you need to ask yourself, what if the other creditors also chose to harass me, or collect against me? Would I be able to service that remaining debt? If not, then just getting rid of the one or two creditors that are causing you problems right now is not going to solve your problem.
I had a client…let's call her Stacy. Stacy came to me and she had over $100,000 in medical debt and credit cards that she was using to service the medical debt. Over the past two years she had eliminated about half of her debt by negotiating with her creditors. She eliminated about $50,000 of her debt and paid about $20,000 in negotiated settlement payments. Her net gain was $30,000. Unfortunately, she had hit a roadblock, and the remaining creditors were not willing to work with her. The remaining $50,000 in credit cards and medical bills were more than she could afford and she needed to file for Bankruptcy. In practical terms, she wasted the $20,000 that she had paid in settlement payments because she ended up filing for Bankruptcy anyway.
So you absolutely need to take a holistic approach to this process. If it works, it needs to work completely, or don't waste your time and money dealing with only a few creditors in a piecemeal fashion.
One of the relatively unknown downsides to debt settlement is called “cancellation of debt income” or CODI as the accountants like to call it. What this means is that if you successfully negotiate a debt settlement, the amount that was forgiven will be calculated to you as income at the end of the year. Let's say that you had $50,000 in debt and you negotiated settlement payments of $20,000. That means that the Banks forgave $30,000. At the end of the year, this amount will be assessed to you as income. So in the same example, let's say that you make $70,000 per year…guess what? You just made $100,000 that year, and for that additional $30,000 there was no withholding for taxes by your employer, so the tax hit could be severe.
Now for low income wage earners, CODI income does not really amount to much, and for anybody that eliminates their debt by filing for Bankruptcy, they are completely exempt from CODI income, but if you settle your debt, be prepared for a tax penalty and you should talk with your tax adviser well before the end of the year to make sure that you are not causing more problems than you are solving.
Now, none of this means that debt settlement is a bad thing. It just means that you need to go into the process with your eyes wide open. It is not a perfect solution to your problems and there will be some work involved. On that note, in my next blog post, I will talk about some of the practical ways to negotiate a debt settlement.