WHICH AVENUE TO CHOOSE - A Debtor's Path to Financial Recovery

Author: Shaun Morrison, Compliance Specialist

An old proverb once said, "Better to go to bed hungry then wake up in debt".  Obviously the author did not live in the 21st Century.  In today's age, most of us are constantly aware of, and concerned with, our financial situation - whether it is finding a way to afford sending a child to school, paying the bills, or simply saving enough for this week's groceries.  Each burden may land us in a situation where the cost is more than we can bear.

Incurring debt always causes a stir; but, lo and behold, there are options available. The lynchpin is having the availability to choose the right one.  Inevitably, the choices boil down to three; Bankruptcy, Debt Settlement, or Debt Management.  Each offers a different approach to regaining financial security and a sense of relief.

Bankruptcy boasts a "fresh start," the end of debt and the promise of a new beginning.  While this option is palpable for some, it is not the best option for all.

First, let us begin with the basic layout.  There are two types of consumer bankruptcy plans; liquidation or a payout.  When a consumer is liquidated (Chapter 7), all non-exempt assets are sold off with the proceeds benefiting creditors.  After the proceeds are distributed, the consumer's remaining debt is discharged (essentially extinguished).  In contrast, a payout plan allows the consumer to retain all of their assets in exchange for their promise to pay off all or a portion of their debt over a fixed period of time (Chapter 13).

Liquidation is the basic principal behind bankruptcy.  The debtor is allowed to discharge their debts and regain their ability to contribute to the marketplace.  While conceptually this "fresh start" is appealing, only a few are eligible to embrace it.  Congress adopted a "Means Test" to determine whether or not consumers are qualified for a discharge.  In essence, the determining factor is whether the consumer's income exceeds the median income of households situated in a similar area as theirs.  If their income is lower, they qualify.  If it exceeds the threshold, then a more sophisticated calculation is conducted with far fewer debtors qualifying.

Conversely, a payout plan utilizes a consumer's future earnings to pay off their debt.  The debtor agrees to pay a portion of their income to creditors over a period of a minimum of three years.  If the plan is completed successfully, all further debts are discharged.  Such a plan often provides incentives to the debtor that would not otherwise be had in liquidation.

A recent alternative to bankruptcy is the debt settlement industry.  These companies promise a reduction in your debt in exchange for a lump sum payment or for a succession of payments.  However, it is the untold truths that often cost consumers more than they bargained for.  For instance, even a successful debt settlement arrangement negatively affects your credit report.  Credit agencies will report your account as either "Charged-Off Settled" or "Paid Settled".  Each indicates a settlement arrangement that is considered far worse than a paid in full report.  Further, settlements remain on your credit report for up to seven years, limiting your ability to obtain future credit.

In addition, the Internal Revenue Service considers settled debts as earned income which, in turn, requires the debtor to pay income taxes.  Moreover, debt settlement companies are likely to charge large upfront fees for their services.

In retaliation, the Federal Trade Commission has outlawed debt settlement companies from obtaining fees prior to settling a debt.  Likewise, New York State has introduced a Bill in an effort to curtail the debt settlement industry by requiring detailed disclosures and a no fee policy until a debt has affirmatively been settled.  While not all debt settlement companies are disreputable, the industry remains a caveat of "buyer beware".

Debt management is a unique option that affords debtors the opportunity to repay the principal of their debt in full.  Debtors attend a counseling session to determine whether or not a debt management plan is the proper avenue in light of their situation.  A debt management plan, or "DMP", is an arrangement whereby the debtor makes monthly payments over the course of a maximum of sixty months to fully repay their debt.  Debt management agencies negotiate with creditors to reduce standard monthly payments to a denomination that is capable of repayment based on a particular debtor's circumstances.

Debt management agencies differ from debt settlement companies in many ways.  First, debt management is a highly regulated industry.  Nearly every state requires a license to practice debt management and compels annual renewals.  Further, legitimate debt management agencies are certified by third party organizations and offer only accredited counselors.  Valid certificates evincing the fact are required to be displayed throughout their offices.  Most notably, debt management agencies are predominantly not-for-profit, unlike for-profit debt settlement companies.  Despite this, debt management agencies tend to provide free consultations, and counselors assist in managing a debtor's DMP for nominal monthly fees.  While no system is perfect, debt management agencies offer a realistic opportunity for financial recovery, but require dedication and resolve by the debtor.

Suffering from debt has plagued consumers for centuries, and the options for relief have taken many forms.  A good organization does not seek financial gain; rather, they provide the debtor with multiple avenues to consider.  The choice to seek help or remain complacent is ultimately up to the debtor, but why go to bed hungry when the opportunity for relief is out there?

If you feel your financial health is in jeopardy and would like more information, please contact RethinkingDebt.org by calling 1-888-724-2227 or visit www.RethinkingDebt.org.