by Adam Mack, J.D.
What other options do I have for debt relief if I don’t file bankruptcy?
Most people who consider bankruptcy are overwhelmed by debt, frequently due to things beyond their control such as job loss or unexpected medical bills. When faced with the reality that they are in over their heads, one of their first questions is usually, “What are my options?” Though we most often talk about bankruptcy, it’s only one of your options.
Other Forms of Debt Relief
Generally speaking, there are three ways to get rid of a debt: pay it off, settle it, or discharge it by filing bankruptcy. We’ve already taken a more in-depth look at bankruptcy elsewhere, but just like with bankruptcy, there are advantages and disadvantages to other forms of debt relief.
Paying Off Debt
For the vast majority of people who are overwhelmed with debt, they would much rather be able to pay off their debt than file bankruptcy or even attempt to settle the debt. Sometimes people have the resources to pay off their debt but don’t know the strategies that can make that goal possible. One of the most famous proponents of debt-elimination strategies is probably Dave Ramsey (please note that we are not affiliated with Dave Ramsey and take no responsibility for the content or advice given on his website). While they’re not glamorous, strategies like budgeting and snowballing debt can help many people effectively manage their debt.
The advantages of paying off your debt over other forms of debt relief generally include better credit scores, no fees for attorneys or other agencies, and a sense of satisfaction.
Unfortunately, sometimes there simply isn’t enough money to make ends meet even after implementing these payment strategies. In those circumstances, paying off debt is not a viable option.
When people hear “settling debt” they often think of debt relief agencies, but really, it’s just negotiation with the creditor to reduce the amount due. Often, a debtor can negotiate with the creditor directly, and even home loans can sometimes be settled.
The most common form of settling real estate debt is through a short sale, in which the home is sold for less than (or “short” of) what is owed on it. The specific terms of a short sale agreement vary, but usually the debtor is responsible for the difference between the principal owed and the selling price of the house, often times referred to as the “deficiency”. In a deed in lieu of foreclosure, the debtors “deed” (or return) the house to the bank and thus prevent foreclosure. Usually a deed in lieu is a viable option only for people who owe less than what the house is worth.
The advantages of settling debt generally include reducing or eliminating the principal owed and avoiding bankruptcy. Especially if the dollar amount owed is not significant, it can sometimes be a good option.
Unfortunately, there are no guarantees when a debtor attempts to settle debts and so debtors need to make a careful risk analysis first. In bankruptcy, the debtor has the right to debt relief; a debtor has no such right when it comes to debt settlement. In an attempt to coerce creditors to work with a debtor, debt relief agencies regularly advise debtors to stop paying their creditors altogether to make the creditor desperate enough to negotiate. Needless to say, while in some circumstances this tactic may be effective, it also has a significantly negative impact on one’s credit, and often the damage is worse than just filing bankruptcy.
Debt relief agencies also charge a fee to do business with them and, if the creditor won’t negotiate, the debtor often has to file bankruptcy anyway. At that point, the debtor has probably also spent a considerable amount of money on the debt settlement company and now has the cost of a bankruptcy attorney as well.
An additional danger with debt settlement is the tax liability. Any time a debtor successfully settles a debt that results in a debt cancellation that is equal to or greater than $600, the creditor has to file a 1099 with the IRS stating the dollar amount settled. Except in a few highly unusual circumstances, the IRS then considers that dollar amount to be taxable income for the debtor. So, for example, if a debtor owes a creditor $20,000 and successfully settles it for 15%, he or she owes the creditor only $3000, but the IRS adds $17,000 to his or her taxable income. This can be a devastating tax burden, especially if that additional “income” bumps a debtor up into the next tax bracket. Bankruptcy does not have a similar tax liability.
The Most Important Part
There are advantages and disadvantages to every form of debt relief, and in our office, we have helped our clients resolve their debt problems though all three means – payment strategies, debt settlement, and bankruptcy – based our client’s individual circumstances and financial goals. We’d be happy to do the same with you.