Reader Question: Which is Worse for Credit Score, Settlement or Bankruptcy?

Hello Lee!

I, like all of the people on here, am stuck in a bad situation and I don't know what to do. I went thru a nasty divorce that lasted 3.5 years and in that time I was a single mom trying to survive. All money I made went to lawyers, a roof over our heads and food. I had to take loans out and credit cards to just buy groceries. I'm slowly (I mean SLOWLY!) getting back on my feet. I'm looking at $27,00.00 in debt. I thought about filing bankrupt papers but wanted to look into setteling my debts with the CA. Which would kill my credit more you think? It literally has been years since I paid anything. I think last year I paid $50.00 to each company (4 of them) to get them to stop harrassing me on the phone. You seem to give amazing advice! Please Help!!!

Monica

Monica,

Unfortunately, $27,000 is a large enough amount that a collection agency wouldn't hesitate to sue. I'm hoping this $27,000 is your total debt and not your debt to a single creditor. That might make this situation easier to manage. 

You made a mistake by paying them anything. Each time you send them money, that resets the statute of limitations for a lawsuit. You don't mention which state you're in, but the SOL ranges from 4-6 years in most states. 

Your position to settle depends on your ability to pay. For example, if you have a job, money in the bank or own property, such as a home or car, the collection agency can sue you and force you to pay the full amount by garnishing your wages, emptying your bank accounts and seizing and selling your property. When you contact a CA you haven't heard from or spoken with in a long time and propose a settlement, all you're basically saying is "I have money now! Come and get me!" So, of course, the CA begins to rabidly pursue you (usually for the full balance). 

The older an account gets, the less likely it is that the CA will get paid and the more likely a CA is to accept a settlement. They'll generally send you a settlement proposal in the mail. Once you know the company is ready to settle, you can then call the company and negotiate back and forth. Negotiate up, not down. For example, name a lower number than you can afford to pay and let the collector bring your price up. Don't start from the collector's settlement offer and start negotiating down. This is a cheap psychological trick, but it often works. It makes the collector feel that he's "won" by getting you to pay significantly more than you offered while simultaneously helping you get a lower settlement than you would have gotten by negotiating down from their offer. 

Settling with the original creditor on a debt will decimate your credit, that much is true. Settling with a collection agency, however, won't. You see, the collection account on your report is as bad as it can get. It can't get any worse. So whether its paid, unpaid or settled, its still a collection account and it still affects your credit rating exactly the same. In general, however, bankruptcy is always worse for your credit report than settling with anyone. And if you file Chapter 13, you have to pay those debts back anyway – sometimes in their entirety.

Now, since you mentioned bankruptcy, here's where things get interesting. If you end up filing for bankruptcy, the collection agencies get NOTHING and they can't sell the debt either. If and when you call for a settlement, tell the collector you speak with that you are filing for bankruptcy if you can't get these debts taken care of. The word "bankruptcy" will usually make creditors much easier to work with. After all, you've got them over a barrel. They either work with you and give you a reasonable repayment option or they get nothing. 

If bankruptcy is really an option, I wouldn't make a single payment to any of these creditors until you've got settlement agreements IN WRITING from each of them. The last thing you need is to settle with several of them only to have the last sue you and force you into bankruptcy. If you end up filing bankruptcy anyway, paying the first few settlements was nothing more than a big waste of money. It's all or nothing here. 

Oh, and if you're outside of the SOL in your state for any of these debts, feel free to twiddle your fingers until they go away. They can't sue you. You can send a written request that they stop telephoning you and they have to adhere to it. It's just as effective as sending a payment and, if the SOL has expired, a whole heck of a lot safer. If the SOL hasn't expired, let them call. Prohibiting contact with an SOL that's still in effect is just begging for a lawsuit. 

If you have any other questions, feel free to ask. 

Best of luck to you, 

Lee