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Clients sometimes ask me whether or not they really should file bankruptcy and if there is any other way to get rid of their debt.  There is a way to get rid of your debt without filing bankruptcy, and that is by making settlements with your creditors.  It is important to note that you do not need to hire one of those debt settlement companies to do this, and in fact, you should not hire one.  Those companies don't have the ability to get any better settlements for you than you would yourself, plus you are giving the debt settlement company money every month that you could be using to pay off your debt. Usually, for a settlement plan to work, you need to stop paying your debts for at least 8 to 12 months. 

You won't get sued in that amount of time, and your creditors will be willing to settle on the debt from anywhere to 35% to 50% on the debt.  However, you usually have to be able to make a lump sum payment to get the best offer.  The creditors won't make any offers if you are on time with your payments; it is only when you become severely delinquent that they will start to negotiate. Note that you need to be able to save money every month, or know you are going to be getting a large tax refund or other lump sum award, so that you can make the lump sum payments to your creditors.  Also, remember that this plan depends in large part on the amount of debt you have.  If you have $10,000 in debt, you could probably do this.  If you have $100,000 in debt, probably not.

There are lots of pitfalls you need to be aware of when settling a debt and here are just a few: 1.  You could settle some of your debt, get sued by a creditor before you can settle that debt and end up filing bankruptcy anyway.  You would then have paid back a lot of debts you would not have had to pay back had you filed bankruptcy from the start. 2.  You will have to pay income tax on the debt that is forgiven.  That's right.  Unless the debt being forgiven is debt on your primary residence (and there are several exceptions to even that exception), you are going to pay income tax on the debt that is forgiven.  So for example, if your credit card debt is $25,000, and you pay $15,000 and get the remaining $10,000 forgiven, you will pay income tax on that $10,000.  So if your annual income was $50,000, you would have another $10,000 added on to that when you file your return.  Of course, the tax on $10,000 is still a lot less money than paying the actual $10,000. NOTE:  You can argue to the IRS that you are insolvent and should not have to pay income tax on negotiated debt settlements.  There is a form you have to fill out and the IRS looks at all your assets, including your house, your cars, your retirement etc. in determining whether you are insolvent.  You should use an accountant to help you with this form if you decide to go this route.

But taxes are not dischargeable and depending on what your other financial obligations are, that tax liability could be difficult to handle.  Remember, however, the IRS will generally make a payment plan with you for most IRS liabilities under $15,000. 3.  Making settlements still trashes your credit.  You won't get any deals unless you go at least eight months without making payments. 4.  You have to put up with months of relentless, abusive phone calls from creditors. 5.  The interest and late fees will add to the balance - so even if get a creditor to accept 50% of a balance - that 50% is going to be higher than what 50% of the balance was at the time you stopped paying. These are just a few of the pitfalls of debt consolidation.   Be sure to speak with a qualified bankruptcy attorney who can help you understand the risks and benefits to you.