Some people with overwhelming debt may try other options before considering bankruptcy. One of these options is a debt consolidation plan, wherein they send payments to a company that will deal with the debt on their behalf. This is often a bad idea. Talk to one of our New Jersey attorneys about comparing Chapter 13 bankruptcy to debt consolidation plans and why filing for bankruptcy is almost always preferable.
With a Chapter 13 bankruptcy, the debtors get the benefit of the automatic stay, which goes into effect upon the filing of the bankruptcy. Their creditors get notice and they are prevented from trying to collect from them in any way, including pending lawsuits or Sheriff Sales. The creditor can no longer send statements to the debtor, cannot call them, seek collection, sue them, and they also cannot report negatively on the debtor’s credit. That is what allows the debtor to get the fresh start because there is no more negative reporting to the credit bureau. The bankruptcy should be the last negative item reported to any of the credit agencies by the creditors.
In a debt consolidation plan, there is no stay on collections and creditors can proceed with filing lawsuits against the debtor. The debt consolidation company would look at the person’s budget and income, and they will come up with a plan for how much money to send to them to pay down the debt. The initial five or six months’ worth of payments all goes to the company for their fees. After that, the company starts escrowing the money into an account to deal with the client’s creditors.
Many people try a debt consolidation plan before they come to an attorney to discuss bankruptcy. What these debt companies never tell people is that they are taking their fee upfront. It is usually not spelled out directly, so people are surprised that they pay for five or six months and nothing has gone to the creditor. They also typically do not tell debtors that there is no automatic stay. The creditors have no legal obligation to deal with the debt consolidation company or follow their requests.
What ends up happening is that many of the creditors start lawsuits. They are reporting negatively on the individual’s credit every month. Generally, debt consolidation ends up hurting the client’s credit much worse than a bankruptcy would. It is very rare that these companies end up working out a successful payment plan with creditors.
The goal of these debt consolidation companies is to negotiate the debt. Generally, they do not do that until there is a judgment entered against the client because it is easier for them to deal with an attorney’s office than to deal directly with credit card companies like Chase or American Express.
If the plan goes as proposed, they now have money in an escrow account and they will go to the bank and offer the amount of money in that account in exchange for forgiving the remaining debt. If the credit card company agrees to it, then the debt is considered satisfied, but the credit card will send the client a 1099 tax form at the end of the year for the amount of debt that they forgave. The forgiven debt becomes income that the debtor will have to pay taxes on.
That is one of the other things these debt consolidations are not upfront about. They do not tell clients that they are going to pay taxes on any debt that is forgiven. In a Chapter 13 bankruptcy, the discharged debt is not taxable.
The only reason a lawyer might suggest trying to resolve debt versus filing a Chapter 13 is if the debtor has a lump sum of money available at the time, such as receiving a large inheritance that is big enough to cover the amount owed.
A debtor who has no savings in their bank account should not opt for debt consolidation because none of these creditors are going to agree to take payments over time. It is all lump sum. The debtors get fooled into thinking that they are in some kind of payment plan with their creditors because they are sending money to the debt consolidation company, but the money is just sitting in a trust account and is not going to their creditors until the consolidation company gets the creditor to agree to a certain lump sum dollar amount.
Debt consolidation might be beneficial if the debtors have too much equity in their assets. Maybe they have vehicles that are paid in full and have no liens on them, or a stock account that has a good amount of money in it. Those things would factor into how much they would have to pay back in a Chapter 13. If we can access money somewhere and negotiate some of the debts down versus paying all of it back in a Chapter 13, that may be another scenario where we would work out with their creditors.
There are many hidden aspects to debt consolidation companies that most debtors are dismayed to learn about. Fortunately, you have better options. Speak to a member of our New Jersey-based team about why it is in your best interest to file for Chapter 13 bankruptcy instead of signing up for a debt consolidation plan.
Gillman, Bruton, Capone Law Group
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