Differences Between Chapter 13 Bankruptcy and Debt Consolidation
One of the questions most often asked by our clients is about the difference between bankruptcy and private debt-consolidation companies. Many debt-consolidation companies (also known as debt-relief companies) advertise debt consolidations plan a way out of debt without having to file for bankruptcy. Their clear implication is that their services are better for you than filing for bankruptcy. While some people may indeed eliminate their debt with debt-consolidation companies, many do not. And even when people do eliminate their debt with debt-consolidation companies, that does not necessarily mean they got better results than they would have if the had chosen bankruptcy instead. When considering debt relief options there are important differences people need to understand to make an informed decision. Here are some of the differences:
The Automatic Stay
Unlike with a private debt relief company, when you file a bankruptcy case you are immediately protected from your creditors by a law known as the “automatic stay.” The automatic stay prohibits your creditors from calling or writing you to demand payment and immediately stops any lawsuits, wages garnishments, or levies on bank accounts or other assets. Creditors are well aware of the automatic stay and what it means and they abide by it. In contrast, for-profit debt relief companies offer no such protection. While they may be negotiating with your creditors to settle your debts, your creditors remain free to pursue collections by any means, including suing you.
Pay Less With Bankruptcy
There are two basic bankruptcy options available to people: Chapter 7 and Chapter 13. Chapter 7, or “straight bankruptcy” eliminates most types of debt including credit cards, medical, bills, pay day loans, and even some taxes, with no payment plan to creditors. Chapter 7 is available to lower-income individuals, people with large households, people whose debts are business related, and other particular circumstances. In some cases, usually where an individual’s income disqualifies them from Chapter 7, Chapter 13 is another option where you propose a payment plan to creditors. This payment plan is based on what you can reasonably afford to pay each month and lasts between 36 and 60 months. In many Chapter 13 bankruptcy cases, the required payment can total 10% or less of the amount owed, with the remainder being discharged at the conclusion of the case. Creditors are bound by the plan and cannot object or opt-out simply because they are unhappy with their payment. Once the payment plan is completed, any unpaid debt is forgiven permanently.
Debt consolidation companies have little bargaining power in dealing with creditors. If you owe the money, they have the right to all of it, and aren’t required to consider one’s particular circumstances or how much they might owe others. As such, they are unlikely to agree to as little as 10% of the amount owed. Often, debt consolidation companies are unable to get reductions of more than of 30-50% of the balance owed.
Bankruptcy Discharge Has No Income Tax Effect
Under the Internal Revenue Code, and most state revenue codes, the forgiveness or cancellation of a debt is counted, and taxed, as regular income. This means that if a debt consolidation company is able to settle your $10,000 debt for $6,000, the creditor will be sending you and the IRS a Form 1099, and you will have to pay income tax on the $4,000 that was forgiven. Many people are not even aware of this when they settle their debts and are quite surprised when they receive the tax bill. When a debt is discharged in a bankruptcy proceeding, it is never counted as income for tax purposes, providing a truly fresh start.
Stop Interest and Late Fees
When you file a bankruptcy case, the interest and penalties stop accruing on your debt. In a Chapter 13 case, the payment plan is based on what you owed on the day you file. As such, the payments you make in Chapter 13 are actually being applied to what you owe, and not to interest and late fees.
While you are in a debt consolidation plan through a private company, normal interest and penalties continue to add up, increasing your debt. Debt consolidation plans can sometimes last several years before claims are finally settled, meaning potentially thousands of dollars of additional debt. If the debt consolidation plan is unsuccessful (and they often are) you may end up in a worse position than when you started. Also, if the debts are ultimately settled, the additional interest and penalties that are wiped out will be counted as taxable income to you, potentially erasing any benefit of the debt consolidation in the first place.
Have An Attorney By Your Side
It is difficult the underestimate the importance of having an experienced advocate by your side when going through a difficult time in life. Most attorneys who practice bankruptcy law, including those at our firm, specialize in bankruptcy law. They know the ins and outs of the law, the right questions to ask you and the answers to your questions. They will assist you in preparing all of the forms, attend court with you and attorneys are governed by strict ethics rules that require them to be a zealous advocate for you as their client. A bankruptcy attorney’s goal is the same as yours, to get you out of debt in as little time and at as little cost to you as possible.
Employees at debt consolidation companies are not required to have any particular skills, training or expertise and they are sparsely regulated. Many times, they will not be able to answer your specific questions and cannot offer legal advice. Their job is simple, sign you up, get you to start paying and keep you paying for as long as possible in order to generate revenue for their company. Usually, debt consolidation companies charge you monthly and they want you to stay in their program as long as possible, meaning they have no motivation to get you out of debt.
There are many differences between bankruptcy and debt-consolidation plans that are important to understand them before deciding how you are going to handle your financial situation. Lipton Law Group can help explain how these differences apply to you so you can make the best decision for yourself. Call us today for a free consultation.