Debt Settlement vs. Bankruptcy: 5 Things to Consider

Amber Westover

Last Updated: August 13th, 2020

Your debt is overwhelming. You can no longer pay your bills and you are falling behind financially. Perhaps you receive weekly collection calls. You know there is no way for you to pay back your creditors, so you are seriously considering bankruptcy. However, before you start dialing an attorney, consider your other options, particularly debt settlement.

What Is Bankruptcy?

Bankruptcy is a legal procedure that reduces or eliminates debts. Eligible individuals receive court protection during the bankruptcy proceedings. Through the process, assets are either liquidated to pay off debts or the court creates a repayment plan to help the consumer pay off debts over time.

There are two main types of consumer bankruptcy, Chapter 7 and 13. In 2016, approximately 62 percent of the 770,846 non-business bankruptcy filings were Chapter 7, making it the most popular type of filing. During Chapter 7 bankruptcy, your nonexempt assets are sold and used to pay creditors. After the process is complete, remaining qualified debts are discharged. Certain types of debt, such as tax and child support, are not applicable. On the other hand, during Chapter 13 bankruptcy the court works out a repayment plan, equal to the value of your nonexempt property. Once this is complete, remaining qualified debts are discharged.

What Is Debt Settlement?

Debt settlement is a very different process. A settlement company will analyze your debt and financial situation, often during a free consultation, and create a plan to help you get out of debt. Often, they will ask you to make monthly deposits into a designated savings account, rather than paying your creditors. The accumulating sum is used in the negotiation process. The debt settlement company negotiates with your creditors to settle your debt for a lower amount than you owe.

Top 5 Things to Consider

While deciding between bankruptcy and debt settlement, there are several important factors to consider. Both decisions have short-term negative consequences, but can be beneficial long term. Consider the following five things before you make your decision:

  1. Eligibility
  2. Credit Impact
  3. Resolution Time
  4. Cost
  5. Tax Consequences


The first critical factor is eligibility; not everyone qualifies for bankruptcy. Additionally, many debt settlement companies have minimum debt requirements. Before choosing your course of action, you need to determine if you qualify for either method.

Bankruptcy: One important eligibility requirement for Chapter 7 bankruptcy is income. If your income is less than the median for your state and household size, you will likely qualify. In addition, your amount of disposable income is a large factor. If you have little income after taxes and necessary expenses, such as food, you may be eligible. Additionally, debt that exceeds half your income or would take over five years to pay off indicates that you are a good candidate for bankruptcy.

Chapter 13 bankruptcy has different eligibility requirements. Your debt cannot exceed a certain amount, $394,725 for unsecured debts and $1,184,200 for secured debts. You also must have sufficient income to satisfy a repayment plan and be current on your federal income tax returns.

Both types of bankruptcy have several additional strict requirements. If your debt was recently discharged in a prior bankruptcy case, dismissed from a case within the past 180 days, you have attempted to defraud your creditors, or you do not attend mandatory credit counseling, you will not qualify.

Debt Settlement: Each debt settlement company establishes its own eligibility requirements. Most companies only work with unsecured debt. Additionally, few companies operate in all 50 states. You need to verify which companies service your state. Finally, most debt settlement companies have a minimum debt requirement. Many companies require $7,500 to $10,000 in debt. However there are some companies that require as little as $5,000. If you have less than $5,000, you should look seriously at other debt relief options, such as debt management plans or consolidation.

Credit Impact

Both bankruptcy and debt settlement will negatively impact your credit score and report. The severity and the length of the impact needs to be seriously considered. Your credit score affects your ability to apply for loans and may dissuade landlords from renting to you. It significantly impacts your interest rates on loans, credit cards, and mortgages. Moreover, if you apply for a job with security clearance or in a financial industry, your credit score may be an influential hiring factor. After either method, you may consider using a credit repair company to help monitor and improve your credit.

Bankruptcy: Bankruptcy will greatly impact both your credit score and report. Your score could decrease by 160 to 220 points. Chapter 7 bankruptcy stays on your report for 10 years; however, your discharged debts are removed after seven years. On the other hand, Chapter 13 bankruptcy stays on your report for seven years. You pay off many of your debts over a three to five year period; these may remain on your report for longer than seven years.

Debt Settlement: If your debts are settled for less than the full amount, your credit report may read "Settled" rather than "Paid in full". Additionally, part of the settlement process involves making payments to a designated savings account, rather than paying your creditors. These missed payments will decrease your score. If you are already late on your payments, the impact will be less severe; however, if you have a high score, the drop will be more dramatic. In either case, debt settlement is still less damaging to your credit than bankruptcy.

Resolution Time

Debt resolution is rarely a quick process. Compare the length of each option before making your final decision. Think about your future financials goals and how quickly you need your debt resolved.

Bankruptcy: Bankruptcy can take a few months or years. Chapter 7 bankruptcy is the shortest option. It typically takes four to six months. In contrast, Chapter 13 bankruptcy takes between three and five years. Over these years, you make regular payments as outlined in your court-approved repayment plan.

Debt Settlement: The settlement process varies greatly based on individual circumstances. Many companies, such as Accredited Debt Relief, aim to have their clients debt free in two to four years. However, speaking to a company about your specific situation will give you a more precise time estimate.


If you are considering these two options, then you are struggling with notable financial hardships. You want to choose the option that makes the most financial sense. Take time to calculate the cost and see which option is best for you.

Bankruptcy: There are several costs associated with bankruptcy. Chapter 7 costs $335 in filing fees, and Chapter 13 costs $310. In addition, many people hire bankruptcy attorneys, with an average fee of $1,250. You do have the option to file without representation, called pro se. However, a study of 2014 Central District of California bankruptcy courts found that only 48.2 percent of pro se cases resulted in a bankruptcy discharge (released liability from debts) compared to 82.1 percent of attorney represented cases. Though legal representation offers a higher success rate, it dramatically increases costs. Finally, one of the conditions of bankruptcy is credit counseling. Depending on your income, this could range from $0 to $50.

Debt Settlement: Companies typically charge a percent of your enrolled debt, though a few companies base fees on saved debt. Pacific Debt Inc. charges between 15 and 25 percent of total enrolled debt for their services, a typical fee for the industry. The range varies based on state and amount of debt. Be wary of companies that charge upfront fees.

Tax Consequences

Debt relief has surprising tax repercussions. Familiarize yourself with these consequences. You do not want to pay off your debt only to receive a hefty tax bill at the end of the year.

Bankruptcy: Canceled debt, in both Chapter 7 and 13 bankruptcies is not included in your income. Unlike other forms of forgiven debt, this is not taxable. To report this exclusion, you will need to fill out line 1a on Form 982.

Debt Settlement: When your debt is canceled, your creditor will report it to the IRS through Form 1099-C. The IRS views this forgiven debt as taxable income. Unless you can prove insolvency (your debts exceed your assets), you will be required to pay taxes on the forgiven amount.

The Final Choice

As you decide your course of action, be sure to consider the aforementioned factors. You first need to establish if you qualify for bankruptcy or debt settlement. Your credit score will be impacted less drastically with debt settlement. Also consider the time and cost. Chapter 13 and debt settlement will most likely take a few years, while Chapter 7 only lasts a few months. During Chapter 7, your assets will be liquidated. If you are interested in retaining your possessions, debt settlement or Chapter 13 may be better options. Finally, remember that debt settlement is often taxable; include this in your cost estimate as you weigh your options.

If you decide to file for bankruptcy, be sure to find a reputable attorney. They can give you specific legal advice for your unique situation. If you decide to resolve your debts with a settlement company, compare top-rated companies. You can read reviews from real customers and compare companies at

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