Chapter 13 vs Debt Settlement: Which is More Cost-Effective?

 Chapter 13 versus Debt Settlement: Which is More


Often  clients are forced with a choice between Chapter 13 bankruptcy or debt settlement, because they cannot qualify for a Chapter 7 bankruptcy. This can happen for several reasons: possession of assets which prohibit them from filing a Chapter 7, or income that is too high to qualify for a Chapter 7 bankruptcy.

Of course, if you have cash assets, creditors prefer debt settlement, as “cash is king”.  Often this method is best in the eyes of both creditors and debtors.

In counseling clients about this dilemma, I like to break it down to one simple question: which is more expensive?  In answering this question we can come up with a simplified understanding of comparative benefit, and decide which approach should be taken.

To begin, it’s useful to understand that debt is always settled as a percentage of a face amount. Whether you owe $5,000 or $15,000, to the creditor it’s all the same: “What percentage can I collect?”  Creditors generally have a huge number of accounts, and their main goal is to see how much of the money owed they will be able to recover.

Generally, a 40% to 60% settlement is quite a good deal for the debtor. A settlement at 80% to 90% of the original debt is often more than the borrower feels he can afford. Obviously a 80% to 90% settlement is optimal for the creditor, preferably paid immediately.

For ease of the discussion, I’ll discuss this in terms of percentages, not dollars. In other words, when we talk about debt settlement versus Chapter 13 bankruptcy the primary question I wish to address for my client is: “what percentage of the debt must be repaid?”

In a Chapter 13 bankruptcy, where the borrower has an annual household income of $80,000-$90,000, it is most likely that he will have to pay back 100% of the debt. Because there are trustee fees and legal fees attached to the proceeding, it is not uncommon that he would pay 115% of the debt. The advantage to filing a Chapter 13 is that you’re given a period of five years to pay off your debts, under a payment plan.

On the other hand, debt settlement may confer a clear advantage, especially if it can be accomplished at 2/3 of the debt (including attorney fees). However, in debt settlement taxes must be considered. Assuming the borrower owes another 13% of the debt in taxes (which will have to be paid within the next year) this means the debt settlement would be the least expensive option. Specifically, that debt settlement would cost the borrower 80% of the original amount owed, after consideration of taxes in calculating the total cost.

In comparing Chapter 13, (which has a total cost of 115%), versus the total cost of debt settlement at 80%, it is clear there is a difference. Specifically, that difference is 35%. In other words, the consumer can often save more than a third of the debt amount, simply by doing debt settlement instead of Chapter 13 bankruptcy.

So looking at the cost-benefit analysis makes it very clear that debt settlement can often be less expensive for the borrower. However, debt settlement is not a good alternative  when the borrower doesn’t have the cash to settle in full at the time the deal is struck. For that reason, Chapter 13 bankruptcy can be an excellent way to arrange over many months the settlement of debt, allowing five years of payments to liquidate the entire debt interest-free, and without the danger of collection lawsuits.

Which one is right for you?  The best advice I can give to you: give us a call at (317) 266-8888. We are happy to answer your questions, and give you sound advice on what can become a very complex matter if not analyzed thoroughly.