Debt Overload, Settlements and Bankruptcy

February 22, 2010 by thinkhappy

Debt Overload, Settlements and Bankruptcy

According to the National Bankruptcy Research Center, Chapter 7 bankruptcies, which allow for the legal removal or forgiveness of most unsecured debt obligations (except government-backed student loans, fines, alimony, delinquent taxes and child support), rose 42% in November 2009 relative to 2008.

In 2005, the government made the bankruptcy laws more stringent which included adding an income means test, forcing people with higher incomes to file a Chapter 13 bankruptcy which involves a debt repayment plan. Consequently there was a spike in the volume of Chapter 7 bankruptcy filings at the end of that year. The change in the filing requirements, however, did not put a damper on the number of filings this past year.

Because of the housing crash and the unemployment explosion, many couples and individuals from a variety of educational and professional backgrounds have been seeking bankruptcy protection as the only means to deal with their debt. This past year, people haven't been trying to find an easy way out of a massive spending spree where they bought designer shoes and European sports cars. Instead the debt has predominantly come from credit cards that were used by the down-sized or unemployed as a means of survival when their income disappeared, from college students who couldn't find loans or part-time jobs so they relied on credit cards to pay basic living expenses, from small business owners who had to pay suppliers while there revenue dried up, and from people with no emergency savings faced with unexpected medical bills.  On top of all this, the housing market shed billions in value as demand came to a screeching halt, so  homeowners have been squeezed from all sides.

Bankruptcy doesn't have the negative stigma that it used to, but it still has the ability to trash your credit report. However, the law was created for a reason - to give you a solution where there isn't another one. It gives you the opportunity to start fresh, at least where part of your unsecured debt is concerned. In fact, studies have shown that most bankruptcies are the result of very high medical debt. Yes, filing for bankruptcy can damage a credit report but if you have been struggling to pay or are unable to pay your debts over an extended period, your credit report will be suffering anyway.

There are lots of commercials on television and radio offering a way to legally eliminate your debt without filing for bankruptcy. In fact, what those companies are doing is getting the lenders to agree to a settlent for pennies on the dollar after your debt has gone into collection, which can take a period of many months. The amount of the settlement isn't guaranteed and all the while your credit score is falling dramatically. And, what the commercials fail to mention, is the fact that when a debt is settled and a large portion is forgiven, the IRS considers the forgiven amount (over $600) as additional income so you have to owe income taxes on it.

A Chapter 7 bankruptcy does stay on your credit report for ten years but if you get out from under a mountain of debt and show financially responsible behavior, paying bills on time and  managing your debt, that negative notation will have less effect over time. Plus, there will be no tax liability after the debt has been legally eliminated.

Written by Hollis Colquhoun 

Learn more about Hollis Colquhoun

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