Differences Between Debt Settlement & Bankruptcy

You have options to explore when trying to deal with personal debt.Andrew Bret Wallis/Brand X Pictures/Getty Images

If you are finding it difficult to meet your monthly financial obligations, you may be considering options such as debt settlement or bankruptcy. Before you seek out the advice of professional financial experts, it is helpful to have an understanding of the differences between debt settlement and bankruptcy. A basic understanding will help you to make a better choice for your situation when you finally do sit down to talk to a financial professional.

Definitions

In order to understand the differences between debt settlement and bankruptcy, it is necessary to know the definition of each. Debt settlement is the process of negotiating a payoff amount with your creditors that is less than what you owe on your account, according to financial expert Liz Pulliam Weston writing on the MSN Money website. Bankruptcy is a structured settlement with your creditors brokered by the federal bankruptcy court, according to online legal resource NOLO.com. There are two basic kinds of bankruptcy for consumers: Chapter 7 and Chapter 13. In a Chapter 7 bankruptcy, the courts will order the consumer to sell some of his assets to pay back creditors, and the rest of the balance due is written off. In a chapter 13 bankruptcy, the courts work with the creditors to create a payment plan to pay back some of the debt in installments. In both cases, the courts will often order the creditors to accept an amount that is lower than the actual owed balance. Another common form of bankruptcy is Chapter 11, but this applies to businesses only.

The essential difference, by definition, between debt settlement and bankruptcy is that bankruptcy involves the courts while debt settlement does not.

A creditor threatened with the bankruptcy of a consumer tends to pay more attention to working with that creditor than a consumer trying to go through debt settlement, according to the Law Offices of Carol D. Ellis. In a bankruptcy, particularly Chapter 7, the creditor may receive nothing. In a debt settlement, the creditor knows that they will receive some form of repayment.

Since bankruptcy is a legal action, once you file for bankruptcy, all credit collections activity against you must stop, according to financial expert Aleksandra Todorova writing on SmartMoney.com. That means that you will be allowed to pursue your bankruptcy settlement without fear of a lawsuit from any of your creditors. When you try debt settlement, your creditors are not bound by any law to stop collections activities. If you miss a single payment, or are late on a single payment, in a debt settlement agreement then your creditors have the option of suing you for the balance due. In the end, debt settlement could lead to more legal problems than bankruptcy.