Comparing desperate options: bankruptcy vs. debt negotiation

Savings spent, deep in debt, jobless makes choices crucial

The Credit Guy columnist Todd Ossenfort
Todd Ossenfort has been chief operating officer for Pioneer Credit Counseling since 1998. He writes our weekly "The Credit Guy" column, answering reader questions about credit counseling and debt issues.

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Question for the expert

Dear Credit Guy,
I am self-employed and haven't had work for over a year. I used up my entire savings trying to "ride this out," and there is still no end in sight. I just now have stopped paying on my four credit cards because I just don't have the money to pay them. I owe a total of about $28,000. I am selling my home to relocate to a new area where I have been offered a job. Here's my question: Do I take my little bit of profits from my home and negotiate a settlement with all of my credit cards and have no money left or do I declare bankruptcy? I am 30 days late on all four cards and watched my credit score go from 688 to 545! I have been told a settlement will not fix my credit score, so why should I use up all my money to pay it off right? My credit is ruined anyway. Should I declare Chapter 7 bankruptcy? -- Justine Answer for the expert

Dear Justine,
I am sorry to hear about your employment situation during the past year or so. The fact that you had enough savings to help weather your lack of income for as long as you did tells me you have made some wise financial decisions in the past. I'm not sure how you ended up with $28,000 in credit card debt, but even wise people can make the mistake of amassing too much debt. One thing to keep in mind moving forward for wise money management is not only to save money for emergencies such as job loss, etc., but to also keep your credit card balances low. My advice would be to only borrow what you can pay off in 90 days or less.

From the information you have provided, I'd say you have several choices moving forward. First you will need to decide if you want to try and repay what you owe or if you would rather file for bankruptcy. If you file now, before you are employed at your new job, you should pass the means test that is required to file for Chapter 7 bankruptcy where your debts are forgiven. I would consult with a bankruptcy attorney and determine how your house will be treated in the bankruptcy. A person's home is generally a protected asset, but since you are selling, the proceeds from the sale of the house may not be.

The negative to keep in mind if you file for bankruptcy is that it will remain on your credit report for 10 years from the date of discharge. While it is true that the late payments on your accounts have already caused a negative impact on your credit score, a bankruptcy will be even worse. It will make obtaining credit in the future much harder, and any credit that you would qualify for will carry much higher interest rates than if you did not have a bankruptcy on your credit bureau file. In addition, many employers make decisions about hiring and/or promoting based on a person's credit report* and many insurance companies review credit reports to establish premium rates.

If you decide to repay your debt, I would first encourage you to contact your creditors and let them know that you have been without an income for the past year, but have just now missed payments. Let them know you have new employment and request that your accounts be placed on a hardship program. Be sure that you have developed a spending plan based on your new income level so that you know what you can afford to pay each month toward your credit card accounts. If your creditors are not willing to work with you, I suggest you contact a reputable nonprofit credit counseling agency. Your credit counselor can help you develop your spending plan and work with your creditors on your behalf if you still want to repay them.

Settling your accounts for less than owed will not be an option until the accounts are at least 90 days past due. If you decide you want to repay less than what you owe, I suggest you negotiate with your creditors yourself. Stay away from those companies with slick advertisements making false claims of saving you 60 percent and settling your debts for 40 percent of what you owe. Remember, Justine, if it sounds too good to be true it probably is. Keep in mind that while you are waiting for the accounts to be at least 90 days past due, the creditor will continue the collection process. Also, your credit will continue to get worse and many creditors may be leery of lending to you in the future because you did not pay what you owed in full.

Take care of your credit!

*Correction: As originally published, this article said credit scores were used in hiring and promotion decisions; they are not. Credit reports are. See's corrections policy.

See related: 7 simple ways to create an emergency savings fund, A guide for navigating through bankruptcy, A desperate debtor's option: hardship programs, 8 steps to picking a credit counselor, How debt settlement works, how it affects credit scores

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Updated: 01-17-2018