Editorial Policy

Should you settle a debt when you are filing for Chapter 7?

Erica Sandberg

September 19, 2014

QHi Erica,

I have informed all of my creditors that I am filing for Chapter 7 in the near future and they are to stop bothering me. But, today I got an offer of settlement from one. Instead of the $10,600 I owe, they will accept a flat $5,000 if I pay them in 30 days. Is there any benefit to me to accept this deal? —Dean

ADear Dean,

No, there isn't. The offer would be an excellent one if you were interested in trying to satisfy your obligations (although there would be potential tax consequences, that's some major savings!), but it would not make any sense if you're going to use bankruptcy protection. Here's why.Ask Erica

As you're using a Chapter 7, you will almost certainly be absolved of all of your unsecured debts. These include credit card bills, collection accounts and balances owed to doctors and hospitals. This type of bankruptcy protection allows you to enjoy a fresh start. As soon as you know that you're eligible, you can arrange your finances in a way that will help you get back on track.

Accepting a settlement won't help you in this case. Yes, the money would be a boon for the creditor, as even though it's less than half of the actual debt, it would get something rather than nothing. But you would be out thousands of dollars, cash that you could use to establish an emergency fund or to pay off bills that you couldn't include in the bankruptcy, such as an overdue car payment or a delinquent mortgage.

But would accepting a settlement boost your credit rating? Again, no. Surely your credit is already damaged, and as you'll be filing for a Chapter 7 bankruptcy, it will be low for quite some time. Notice of the bankruptcy will appear on your credit report for 10 years. One satisfied collection account that preceded it won't be enough to offset the number plunge.

After the bankruptcy is complete, however, you will be able to take steps to repair the harm that it and any late payments and collection activity caused. You can probably get a secured credit card and charge again, this time paying the creditor on time and keeping the balance at zero. By adding such regular positive data to your reports, you'll earn a reputation as a responsible borrower. It will take time and commitment, of course, but millions of Americans overcome credit problems this way.

Tell this creditor that you intend to follow through with the bankruptcy and that you should not be contacted again. It should honor your request, but if not, you may send a cease-and-desist letter. Ultimately, though, when it receives notice that you filed, an automatic stay will go into effect. At that point, creditors will have to stop collection activities. The stay is so powerful that it can suspend evictions, foreclosures and utility shut-offs until you have your day in court.

Now, don't get me wrong. I'm all for people working out payment arrangements and settlements whenever it makes sense. If you borrowed the money and can agree on a deal in which both parties are satisfied, do it! But in this case, you'd just be throwing your money away.

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