If you’re deep in debt, the first step is admitting that you need to take action. Depending on your situation, it may be just a matter of creating a household budget, tightening your belt, and remaining vigilant until your debts are paid off. If you’re experiencing a financial hardship and can no longer even cover the monthly minimums on your credit card bills, however, you may need to consider much more drastic action. At this point, many people consider either bankruptcy or debt settlement, also called debt relief. You may wonder, though, how much does bankruptcy cost?
It’s a fair question, as the costs associated with bankruptcy can prevent people who need it the most from filing for bankruptcy. While we’re at it, here is another important question you might ask: how much does debt settlement cost? Both debt solutions can offer the prospect of financial relief, but either option will have both short- and long-term impacts on your finances.
The debt relief option you choose will depend on several factors, including your income and total amount of debt, but it’s important to understand the real costs of each. To help you make an informed decision, below we’ll explore the costs of bankruptcy and debt settlement, including up-front expenses and long-term impacts on your credit.
The basics: How much does bankruptcy cost?
If you qualify for Chapter 7 bankruptcy, then that may be your only option for debt relief, since it typically means you don’t have enough income to work out a debt settlement plan or use other options such as credit counseling or debt consolidation. We’ll touch on the basics of Chapter 7, although our focus for this article is Chapter 13 bankruptcy, because it is the option that most closely compares to debt settlement.
The decision to file for bankruptcy should never be taken lightly. Since it’s a legal process, you’ll have to pay court filing fees and often, the costs related to hiring an attorney. Less-obvious costs include the impact on your credit score, rigid debt repayment terms, loss of credit cards and inability to secure new financing, and other potential costs related to the public nature of bankruptcy. Costs specifically related to bankruptcy can include:
The court fees for a Chapter 7 bankruptcy filing are $335, which could be a burden for those most in need; to be eligible for Chapter 7, your assets and income must be below a certain threshold. Court fees for Chapter 13 total $310. While you’re expected to make these payments at the time of filing, the court may grant you permission to make installment payments if you don’t have the cash on hand.
Attorney fees may cost from $1,200 to $2,500, but vary widely depending on where you live and how complicated the case is. Attorneys typically require payment of their fees upfront due to concerns over their clients’ ability to pay, according to the ProPublica article linked above. This may present a conundrum for lower-income people. While lawyers charge more for Chapter 13 cases, (averaging $3,000 to $4,000) they may be more willing to get started without any upfront fees, collecting them later through the debt repayment plan.
The basics: How much does debt settlement cost?
Like bankruptcy, debt settlement is also considered a debt relief option for more severe cases. In order to qualify, you need to be able to set aside enough cash to repay your renegotiated debts. You also need to show you face a financial hardship, such as a health emergency or job loss. While you may try to settle debts on your own, you may be more likely to be successful lowering your debts by working with a professional organization.
Also, as with bankruptcy, there are other costs to debt settlement that may not be so apparent right away, such as the impact to your credit score and the possibility of legal action by your creditors. Costs specifically related to debt settlement include:
Debt settlement fees
It’s prohibited for debt settlement companies to collect fees upfront. Instead, you pay the debt settlement company after each debt is settled, based on a percentage of either the total enrolled debt or the amount of debt reduced. Let’s say the company negotiates your $10,000 debt down to $6,000 and charges 22 percent of total enrolled debt. You’ll pay the creditor $6,000 and pay the debt settlement company $2,200.
In that scenario, you’d pay a total of $8,200 instead of paying your creditor the original $10,000 balance (which, with interest and fees, would probably continue to grow in the absence of any intervention). A study based on 2017 data found that consumers save in the range of $2.60-$2.70 for each $1 spent in fees paid to the debt settlement company.
Potential lawsuits by creditors and collectors
When you enroll in a debt settlement program, you voluntarily stop paying your creditors and instead put that money into a separate account that you control. This is used for paying the negotiated debt amounts. However, during the time you are saving money in this account, creditors or collection agencies may threaten or pursue legal action.
If it’s simply a threat, they are often receptive to the prospect of a settlement. It could be costly (attorney, court fees, etc.) if they follow through with a lawsuit, but many debt settlement companies offer third party legal services to represent their clients should this occur. To ensure you are covered for this type of situation, make sure you work with a reputable debt relief company.
Factors that impact the cost of both bankruptcy and debt settlement
When comparing costs, the attorney and court fees associated with bankruptcy and the fees and legal risks associated with debt settlement barely scratch the surface. The main concerns with either option are the financial impact on your credit score, the odds of slipping back into debt, the effect on your property and assets, and the cost (if any) of your debt resolution becoming a matter of public record. Let’s take a look at the cost factors that pertain to both options, and how they differ for each.
Whether you file for bankruptcy or pursue a debt settlement plan, your credit score (FICO® Score, specifically) will take a hit. This is the numerical rating in your credit report that lenders use to evaluate how creditworthy you are. The higher the score, the more likely you may be receive favorable terms on a loan. When bankruptcy or other signs of financial distress are reported to the major credit reporting agencies, it lowers your score.
After you file, bankruptcy will be part of your credit report for seven to 10 years, negatively impacting your credit score for the duration. This recovery period is typically shorter for those who enroll in a debt relief program. Based on a 5-year study of Freedom Debt Relief clients, the average credit score recovery time for FDR clients is less than four years (45 months), and the median result for graduates is an average FICO® score of about 680 two and a half years after completion. Here is what that might look like: *
*The analysis presented is based off of a retrospective analysis of Freedom Debt Relief Graduates who enrolled from March 2014 through May 2014. Data was procured from a Credit Reporting Agency to facilitate the study. The results presented do not represent a guarantee of what will happen to a client’s credit score and enrolled debt, but rather a backward looking observation of what has happened to our clients’ credit scores and enrolled debt over time.
The high cost of bad credit should also be factored into the overall cost of either bankruptcy or debt settlement. Those with a FICO® Score of 579 or lower have credit that more often results in loan interest rates and a higher rate of denial.
Let’s put this into perspective. Assume you may qualify for a 2.379% interest rate if your credit score is between 760 and 850, but your rate may be 3.968% if your score is between 620 and 639. If you want a 30-year mortgage on a $300,000 home, the higher credit score range could result in a total mortgage cost of $419,967 ($1,167 per month), compared to $513,618 ($1,427 per month) for the lower credit score range.
Additionally, bad credit may be seen as a risk factor for insurers and cause those rates to go up. Other negative outcomes of bad credit include the possibility that it could disqualify you from certain career opportunities; cause an apartment rental application to be denied; result in utilities charging higher deposits; and generally prevent you from building wealth until you’re able to recover.
Property and assets
When you file for Chapter 7 bankruptcy, your liquid assets are sold off to pay your creditors. While Chapter 13 may allow you to keep much of your property, you must pay unsecured creditors (credit cards, student loans, etc.) an amount equal to the value of your non-exempt assets. Debt settlement programs, on the other hand, do not consider the value of your assets at all. While you may choose to sell certain assets to help pay your debts, the program is focused only on reducing the amount of debt you owe, and assisting you in resolving that debt.
Recidivism and long-term impacts
The goal of any kind of debt relief should be long lasting, but that’s not always the case. In fact, 39 percent of those who filed Chapter 13 bankruptcy cases in 2019 had previously filed for bankruptcy within the previous eight years, according to the most recent federal data. If bankruptcy is supposed to be a clean slate, an opportunity to turn your financial ship around, roughly four out of every 10 individuals and households that file for Chapter 13 fail to do so.
Graduates of the most reputable debt settlement programs boast a much better track record. In fact, the recidivism rate for graduates of Freedom Debt Relief returning again to debt relief is less than 2 percent, according to company records—less than one-twentieth of the recidivism rate for Chapter 13 bankruptcy filers. This impressive success rate can be attributed, in part, to the goal of teaching enrollees better financial habits and improving their financial literacy in general.
The cost of failure
While Chapter 7 cases result in a successful discharge of debts 96% of the time, fewer than half of all Chapter 13 cases do. In fact, an estimated 67% of Chapter 13 cases result in failure, since the five-year repayment plan can be very difficult to stick with, especially when unexpected expenses or circumstances arise (such as a layoff or illness). If you miss just one payment, the entire plan can be cancelled, leaving you to come up with a new solution for your debt.
No solution is guaranteed, and that includes debt settlement. However, the process of putting money aside until you have enough to pay off renegotiated debts has been proven to be quite effective. In fact, a study by the American Fair Credit Council (AFCC) found that 95 percent of debt settlement clients realized savings in excess of their fees to debt settlement companies.
Public record vs. private process
When you file for bankruptcy protection, it becomes a matter of public record, which could be a cost to your reputation, especially if you’re a business owner or have an occupation where such information could be detrimental to your career. Debt settlement, on the other hand, is a private process that may be discovered, but is not generally part of an official court record.
When you add up all of these factors, bankruptcy could be a much more expensive process than many people realize. Of course, your decision must be based on your specific needs and goals. Before you choose, however, make sure you understand the true costs, both short and long-term, of either method.
How much does bankruptcy cost? Get informed before you decide
If you’re struggling with debt, it might be time to take action—but figuring out the right debt solution isn’t easy. Debt consultants at reputable debt relief companies will take time to understand your individual needs and help you determine the best debt relief option for you, whether it’s debt relief, bankruptcy, or another solution. Our Certified Debt Consultants can help you find a solution that will put you on the path to a better financial future. Find out if you qualify for our debt relief program right now.
- Developing the Financial Muscle Memory for Long Term Financial Health (Freedom Debt Relief)
- Options for Consumers in Crisis: An Economic Analysis of the Debt Settlement Industry (AFCC)
- Reducing Debt Burden—The Proof is in the Pudding (Freedom Debt Relief)
- Chapter 7 vs. Chapter 13—How Much Does it Cost to File Bankruptcy? (BadCredit.org)
- Five Tips to Improve Your Credit (Freedom Debt Relief)