Should I Declare Bankruptcy or Try Debt Settlement?

You may have heard the old saying that when you’ve reached the end of your rope, you should tie a knot and grab on. Great advice if you’re dealing with a full-length rope, but if you’ve found yourself dangling over a pit of financial disaster and hanging onto a shoestring that’s unraveling, it may be time to look for a stronger rope. For many, this rope takes the form of either bankruptcy or debt settlement.

But how do you know which rope will be the one to save you? In this article, we’ll explore both debt settlement and bankruptcy, lay out the advantages and disadvantages of each, and provide some situations where one is better for you than the other. By the end, you’ll hopefully be ready to jump to the rope that’s right for you.

Part One: Bankruptcy vs. Debt Settlement

What Is Bankruptcy?

There are two types of bankruptcy: Chapter 7 and Chapter 13.

Chapter 7 Bankruptcy

When people think of bankruptcy, this is generally the kind that comes to mind. You start this process by getting all of your financial records together, including loan documents, credit card statements, pay stubs, and bank statements, and complete a number of required documents. The most important form you’ll fill out is your bankruptcy petition.

Once the court approves it, any assets not deemed “exempt” could be sold off by a court-appointed trustee, and the money from these sales is given to your creditors who have filed legal claims. However, it’s important to note that the majority of Chapter 7 cases don’t result in any of your assets being sold.

At the end of Chapter 7 bankruptcy, most of your debts will go away, but there are some exceptions.

Chapter 13 Bankruptcy

Under Chapter 13 bankruptcy, your debts don’t vanish once your paperwork is filed. Instead, they are reorganized into a 3 – 5 year repayment plan. You’ll pay a monthly sum to a trustee, who will then distribute the money to your creditors.

What Is Debt Settlement?

Debt settlement is when you or a representative acting on your behalf negotiate with creditors and get them to accept a portion of your remaining debt balance as repayment. While you can do this on your own, enrolling in a debt settlement program can save you time, money, and energy and actually result in a more favorable settlement for you! Debt settlement, on average, saves people $2.64 for every $1 in fees paid, and more than 95% of settlements result in favorable resolutions (Source).

Part Two: Advantages and Disadvantages

What Are the Advantages and Disadvantages of Bankruptcy?

Chapter 7 Bankruptcy Advantages

  • Your debts will be erased: When completed, Chapter 7 offers a fresh start. Most of your debts will be erased, although there are some exceptions.
  • Quick process: On average, Chapter 7 takes between three and six months.
  • Relief from debt collectors: Once you file, collectors and creditors are notified, and they will stop harassing you.

Chapter 7 Bankruptcy Disadvantages

  • You have to qualify first: Not everyone can qualify for Chapter 7 bankruptcy. You’ll have to undergo what’s known as a “means test” for your financial investments and household income to see if you qualify.
  • Your credit score will take a hit: You’ll lose anywhere between 130-200 points on your credit score, and it will likely stay low for a while.
  • Stays on your credit report: Chapter 7 bankruptcy impacts your credit report for 10 years. Additionally, because it’s a public court proceeding, it also becomes part of the public record.
  • You will likely be audited: When the court appoints a trustee to your case, they are instructed to review your financial history for any signs of fraud. Any inconsistencies or misunderstandings can put you in a lot of trouble.
  • Your cosigners will take a financial hit: If you had any cosigners on your loans, they might end up on the hook for the debts you discharge through bankruptcy.

Chapter 13 Bankruptcy Advantages

  • You can file even if you earn too much to qualify for Chapter 7: If the court rules that you make too much money to qualify for Chapter 7 bankruptcy, you can file for Chapter 13.
  • You can keep your assets: Unlike Chapter 7, your valuables are not liquidated, and attempts to repossess things like your vehicle will stop.
  • Protects cosigners: Chapter 13 bankruptcy does not leave your loans’ cosigner liable to repay.
  • Less stigma: While there shouldn’t be a stigma associated with taking control of your finances, people generally view Chapter 13 bankruptcy as more “acceptable” than Chapter 7.

Chapter 13 Bankruptcy Disadvantages

  • Long process: It can take as long as five years to repay all of your lenders.
  • You’ll have a low credit score: Just like Chapter 7, your credit score will take a hit, decreasing by 130-200 points.
  • No disposable income: Your disposable income (i.e., the money that remains after the essentials are paid) is required to go towards payments.
  • You’ll lose your credit cards: Any credit cards you have on the date you file will be closed.

What Are the Advantages and Disadvantages of Debt Settlement?


  • Substantial savings: The amount you end up paying your creditors through debt settlement is often between 25%-50% of what you originally owed, which means you end up saving money in the long run.
  • Faster credit score rebound: While it’s true that your credit score will take an initial hit, you should see it begin to increase within months of completing the debt settlement program.
  • Avoid hounding creditors: If you choose to hire a debt relief organization, they will take on the responsibility of dealing with your creditors—meaning constant calls and letters to you will stop.
  • Fast results: You can be debt-free in 24-48 months and could see your first debt settled within 4-6 months of enrolling in the program.
  • Private process: Debt settlement is private, meaning future employers, friends, and family won’t know about it unless you choose to tell them.
  • You can keep your disposable income: Unlike Chapter 13 bankruptcy, once you make your monthly program payment, you can use the remaining income for whatever you’d like.


  • Creditors are not required to accept your settlement offer: Unfortunately, there’s no law saying that creditors have to accept your offer.
  • Lower credit score: Because you stop making payments directly to creditors after enrolling in a debt relief program, your credit score will take a hit in the short term but bounce back faster once the process gets going.
  • Your settled debt can be taxed: Let’s say that you had a debt of $20,000, and your creditor agrees to settle the debt with you for $12,000. The IRS considers that $8,000 that you didn’t pay as taxable income.

Part Three: How Do I Figure Out Which Is Right For Me?

When Should I Consider Bankruptcy?

Bankruptcy could be right for you when:

  • You have secured debts.
  • Making debt payments would require you to take money away from your savings or retirement.
  • You’ve lost your job, have been unemployed, or don’t have a steady source of income.

When Should I Consider Debt Settlement?

Debt settlement could be right for you when:

  • You want to minimize the damage done to your credit report.
  • You are already behind on payments.
  • You think that your income may fluctuate, resulting in less disposable income.
  • You want to reduce the amount you are obligated to pay back.

Bankruptcy vs. Debt Settlement: Which is Better?

The hard thing about resolving serious debt struggles is that there isn’t a one-size-fits-all solution—what works for one person may not be the best for you. The good news is that, because there are many routes out of debt, you have many options! And you can explore all of them with a Custom Debt Relief Plan! With no cost and no obligation to explore your options, our experts will help point you in the right direction—whether it be bankruptcy, debt settlement, or another debt relief solution.

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