Alternatives to bankruptcy

Bankruptcy is one option among several

People deal with debt they can't pay in five or six different ways, and bankruptcy is only one of them. Each works differently, costs something different, and leaves different things unresolved. This page describes how each one works. It doesn't rank them.

Working it out with the creditor

Creditors can change the terms of a debt whenever they choose to. Credit card issuers run hardship programs that lower the interest rate or the payment for a set period. Nonprofit hospitals are required to have a financial assistance policy and to tell patients about it. The IRS has installment agreements.

These arrangements are voluntary on the creditor's side, they cover one debt at a time, and they hold only as long as the payments are made.

A debt management plan

A debt management plan runs through a nonprofit credit counseling agency. The agency asks each creditor for a lower interest rate or waived fees, and the person makes one monthly payment to the agency, which passes it along.

• It covers unsecured debts such as credit cards and medical bills.
• The full balance gets repaid. Only the interest and fees come down.
• The Federal Trade Commission says these plans can take 48 months or more.
• Creditors choose whether to take part, and the accounts in the plan are usually closed.

Debt settlement

Settlement means a creditor accepts less than the full balance, usually as a lump sum. A person can negotiate that directly. Debt settlement companies do it for a fee, and their programs work the same way: the person stops paying creditors, saves money in a separate account, and the company makes offers as the account grows.

• Federal rules bar these companies from collecting a fee before they've settled a debt.
• Creditors don't have to negotiate, and they can sue while a program is running.
• Stopping payments adds late fees and interest and damages credit.
• The forgiven amount can count as taxable income.

A consolidation loan

A consolidation loan pays off several debts with one new loan. The debt doesn't shrink. It moves, and the interest rate and term change. When the new loan is secured by a house, as with a home equity loan, debt that used to be unsecured now has the house behind it.

Not paying, and being judgment-proof

For most consumer debts, a creditor can't take wages or a bank balance without first suing and winning a court judgment. Even with a judgment, the law puts some income and property off limits:

• Wages: federal law caps garnishment for ordinary debts at 25% of take-home pay, or the amount above $217.50 a week, whichever is less. Some states protect more.
• Benefits: Social Security, SSI, and veterans' benefits generally can't be garnished for consumer debts.
• Property: each state's exemption laws protect certain property from judgment creditors.

A person whose income and property are all protected is called judgment-proof or collection-proof. The debt doesn't go away. Interest keeps adding up, collectors can still call and sue, and a change in income changes what's reachable.

Time limits apply as well. Each state sets a deadline for suing on a debt, most often between three and ten years, and most negative entries drop off a credit report after seven years.

These protections don't cover everything. Child support, taxes, and federal student loans can be collected from wages and some benefits without a separate lawsuit.

What bankruptcy does that the others don't

• The automatic stay stops every creditor at once, on the day of filing.
• It binds all creditors, whether they agree or not.
• The discharge is a federal court order, and it's permanent.
• Debt wiped out in bankruptcy isn't taxable income.

It also has costs the others don't: a public court record, up to ten years on a credit report, and the risk to property that isn't exempt.

For how the bankruptcy chapters compare with each other, see Chapter 7 vs 13 vs 11.