Chapter 13 Bankruptcy versus Debt Consolidation

By: David M. Serafin

For anybody torn between filing a chapter 13 bankruptcy in Colorado and instead going through a debt consolidation program, as a Highlands Ranch personal bankruptcy attorney, I’d highly recommend that you consider the numerous drawbacks of the latter.

Perhaps the primary difference is that only a chapter 13 will invoke the jurisdiction of the Colorado Bankruptcy Court, which can mandate that a creditor accept a certain payment plan.

Debt consolidation is tedious in that it requires that you directly negotiate with each creditor to lower the debt owed to each creditor. This is a voluntary payment arrangement which a creditor can walk away from at any time. In other words, unlike with chapter 13, where the creditors will be limited in their actions by the court orders entered by the Colorado Bankruptcy Court, debt consolidation offers no requirement that a creditor negotiate a debt or, if the creditor has agreed for the debtor to pay a certain amount of the debt back, the creditor can arbitrarily renege on its agreement.

Some credit card companies will not, under any circumstance, not even accept any debt consolidation payments. In comparison, with chapter 13, the same creditor would likely be prevented from collecting on the debt owed if they refuse to participate in the chapter 13. In other words, the creditor gets nothing and no longer would have the right to pursue you for the debt, if it opts out of the chapter 13 proceeding. With a chapter 13, the discharge order can be enforced against the creditor in court.

Further, with debt consolidation, there is no limit or cap to the amount you’ll be required to pay back to the creditors. Why do debt consolidation instead of a chapter 13 if you’re at the creditors’ mercy by having to pay all of your debt, especially unsecured debt?

By contrast, with chapter 13 bankruptcy, Congress sets forth what you’ll be required to pay back to your creditors, depending on your circumstances. For instance, some chapter 13 payment plans only mandate that you pay back 10% or less of your debt to creditors. The remainder owed will be discharged assuming that you successfully complete the plan. Sure beats paying all of your debt back.

Additionally, from an income tax standpoint, bankruptcy does not trigger any liability on the debt forgiven. For instance, if a lender voluntarily agrees to forgive $200,000 of mortgage debt, the IRS and State Department of Revenue treat such $200,000 as taxable income for the tax year the debt was forgiven. However, bankruptcy (either chapter 7 or 13) fits within an exclusion in the Internal Revenue Code such that you will not incur taxable income on the amount forgiven, even if the lender sends you a Form 1099.

With chapter 13, any creditors which do not abide by the payment plan can be found in contempt of court for knowing violation of the court order. Often, I have clients who still continue to be contacted by creditors in violation of the automatic stay well after the case has been filed. The court can enter sanctions, including attorneys fees, against these same creditors. On the other hand, no such protection exists with debt consolidation plans.

Finally, debt consolidation is almost always more expensive than filing for bankruptcy (under either chapter 7 or chapter 13). The fees charged by debt consolidation companies include the exorbitant amounts of interest and penalties that you continue to pay to creditors, particularly the credit card companies. I cannot tell you how many times a prospective client has come into my office looking to file for bankruptcy after having participated in a debt consolidation programs whereby they continued to pay 25% to over 30% interest, plus penalties, to the debt consolidation companies. Most all of these clients actually owed more after walking about from debt consolidation than before. But, with chapter 13, no further interest and penalties (whether the charges are imposed by the credit card companies, hospitals or the tax authorities) can accrue starting on the date the petition is filed.

Also, debt consolidation companies are not permitted to represent you in court against a creditor.

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