For many people who struggle with debt, bankruptcy is far and away the most cost-effective form of debt relief. However, for those who have significant property that is not protected in bankruptcy (“non-exempt assets”) or higher income, bankruptcy can mean that they have to pay back a lot, if not all, of their debt. For these people, debt settlement may be a more cost-effective solution.

Debt settlement means directly negotiating with your creditors outside of bankruptcy to achieve a reduction in the balance you owe your creditors. Most credit card lenders and medical creditors will accept a fraction of the balance owed in full settlement of the debt. Some creditors drive harder bargains than others, but our experience is that a balance reduction of approximately 50% can be achieved with credit card and medical creditors.

Wink & Wink has the expertise to negotiate the best settlements possible with your creditors.

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Will I lose property if I file Bankruptcy?
What property can I keep if I file Bankruptcy?

Most people who file bankruptcy do not lose any property. This is because each state has Bankruptcy Exemptions, which allow you to protect certain property from your creditors when you go through a bankruptcy. Colorado’s bankruptcy exemptions make it possible for Chapter 7 personal bankruptcy filers to protect their property when filing. Most of Colorado’s Bankruptcy exemptions come from C.R.S. § 13-54-102.

Some of the current exemption amounts and categories in Colorado are:

  • Homestead Exemption: Allows you to protect up to $75,000 in equity in your home. This amount increases to $105,000 if you, your spouse, or a dependent family member is at least 60 years old or disabled. The homestead exemption applies only once to your home. It does not double for you and your spouse in a joint bankruptcy.
  • Vehicle Exemption: Allows you to protect up to $7,500 in equity in up to two vehicles. This amount increases to $12,500 if you or a dependent family member is at least 60 years old or disabled. If you file joint bankruptcy with your spouse, you each get your own vehicle exemption (ex., can enable you to protect up to $15,000 of vehicle equity). The vehicle exemption does not apply to motor homes, ATV’s, boats or recreational vehicles.
  • Household Goods Exemption: Allows you to protect up to $3,000 worth of household goods. If you file joint bankruptcy with your spouse, you each get your own household goods exemption (i.e., protect up to $6,000 of jointly owned household goods). When valuing your household goods and other personal property for purposes of bankruptcy, you should use resale value (ex., garage sale or craigslist) and not replacement value.
  • Clothing Exemption: Allows you to protect up to $2,000 worth of clothing for yourself and your dependents. If you file joint bankruptcy with your spouse, you each get your own clothing exemption (i.e., protect up to $4,000 of clothing).
  • Jewelry Exemption: Allows you to protect up to $2,500 worth of jewelry/watches of yourself and your dependents. If you file joint bankruptcy with your spouse, you each get your own jewelry exemption.
  • Personal Library and Family Pictures Exemption: Allows you to protect up to $2,000 in personal library and family pictures. If you file joint bankruptcy with your spouse, you each get your own personal library and family pictures exemption.
  • Tools of the Trade Exemption: Allows you to protect up to $30,000 in things you need for your job (ex., tools, books, furniture, inventory, etc.) if it is your primary source of income. If the tools of the trade are used for a secondary source of income, the amount you can protect is limited to $10,000. If you file joint bankruptcy with your spouse, you each get your own tools of the trade exemption.
  • Retirement Account Exemption: Allows you to protect any amount in an IRA, 401(k), or pension plan.
  • Whole Life Insurance Exemption: Allows you to protect up to $50,000 cash surrender value of a life insurance policy, if only regular premium payments have been made for at least four years. If you file joint bankruptcy with your spouse, you each get your own whole life insurance exemption.
  • Certain Benefits: Your right to receive certain benefits such as social security, unemployment compensation, veteran’s benefits, public assistance, and pensions is exempt, regardless of the amount.

Wink & Wink will help you determine which set of exemptions apply to your situation. If you have non-exempt property, Wink & Wink can provide you with pre-bankruptcy planning in order to maximize the applicable exemptions. There are many ways to protect your assets under the law so that you keep them through bankruptcy.

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In Chapter 13 bankruptcy, you will have to make payments to the bankruptcy Trustee for three to five years. The Trustee will distribute your payments pursuant to the terms of your Chapter 13 plan. The amount you must pay into the Chapter 13 plan is based on your income, assets and debts. At a minimum, your Chapter 13 plan must cover certain types of debts including certain taxes and arrears on secured debts and domestic support obligations. Income tax liability for returns that have come due in the past three years must be paid through your Chapter 13 plan, but you likely don’t have to pay liability from returns due more than 3 years ago. If you are personally liable for sales taxes or payroll taxes, these must also be paid through your Chapter 13 plan.

Additionally, if you are behind on secured debt such as a car loan or a mortgage and you wish to keep the collateral (ex., vehicle, home), you must pay the arrears (i.e., the amount you are behind on the loan as of the day you file bankruptcy) on this secured loan through your Chapter 13 plan. If you are curing arrears on a secured loan in your Chapter 13 plan, you must also maintain payments on the secured debt as they come due. These payments can typically be made directly to the creditor and do not have to paid through your Chapter 13 plan.

If you are behind on child support, alimony or maintenance when you file bankruptcy, you will likely have to pay these arrears through your Chapter 13 plan. Additionally, bankruptcy law requires you to maintain all domestic support payments that come due during your bankruptcy. Payments for domestic support obligations that come due after you file bankruptcy will typically be made directly to recipient of the obligation and not be paid through your Chapter 13 plan.

Other debts, including your unsecured debt (ex., credit cards, medical bills, personal loans), do not necessarily get paid in Chapter 13 bankruptcy. However, your assets and income may serve as a basis for you to have to pay some of this debt in Chapter 13 bankruptcy. The law states that your creditors cannot do worse in Chapter 13 bankruptcy than they would if you filed Chapter 7. This means Chapter 13 incorporates the asset analysis of Chapter 7, in which the law specifies certain property that you can keep (“exempt”) in bankruptcy. If you have property that is “non-exempt”, you must pay your creditors the value of this property in Chapter 13 bankruptcy.

And you may have to pay even more to your creditors if your income is too high. In particular, if your household income for the six months prior to filing (your Current Monthly Income) is above the median income for your household size in Colorado, the amount you have to pay in Chapter 13 bankruptcy will likely be based on the complex formula of the long-form means test (also used to determine eligibility for Chapter 7 bankruptcy). The formula starts with your average monthly household income and then allows you to take deductions from that income for numerous expenses, including:

  1. Living expenses such as food, clothing, utilities, education and childcare expenses for children under 18, and ongoing medical expenses;
  2. Many payroll deductions, such as taxes, health insurance, term life insurance, and retirement contributions;
  3. Secured debt payments for your home and vehicle;
  4. Other reasonable and necessary expenses for the support of you and your dependents (ex., business expenses); and
  5. Those expenses mentioned above that must be paid in chapter 13 bankruptcy.

Certain expense deductions are based on IRS standards for your household size while others are based on the amount you actually spend. In general, if your income minus these allowed expenses yields a positive number, then you have “disposable income” and you will pay this amount to your unsecured creditors in your chapter 13 bankruptcy plan for 5 years.

Finally, you typically must make regular payments on any debts secured by collateral you intend to keep, such as your mortgage and car loan. While these payments can be made directly to the creditor outside of your Chapter 13 plan, they are typically specified in the plan and required as a condition to getting a bankruptcy discharge at the end of your plan. Alternatively, you can pay a secured debt at relatively low interest through the Chapter 13 plan.

In general, developing the most advantageous Chapter 13 repayment plan for you requires expert legal advice. Chapter 13 bankruptcy is highly complex and adversarial. Wink & Wink has the experience, knowledge and skill to help you get the lowest payment possible in a Chapter 13 bankruptcy.

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Necessary Elements for Settling Debt

In order to achieve a reduction in the balance you owe a creditor through debt settlement, several factors generally must exist:

  • 1) You must be in default of the obligation (i.e., not paying it). The best deal for your creditors is that you pay them according to their terms. So as long as you are doing this, they have no incentive to give you a break. Unfortunately, your personal difficulties are generally not enough to get a deal. You need to represent risk to get the lender to accept less than the balance owed. You achieve this by not paying. Many creditors will start accepting less than the full balance after three months of non-payment.
  • 2) You typically need lump sums of cash to settle debt. Your creditors are not going to replace a promise to pay 100% of the balance owed for a promise to pay 50% of the balance owed. They already have a promise to pay. However, when you are not paying them and represent credit risk, your creditors may accept 50% or less of the balance if that amount is paid in a lump-sum in the relative near-term (i.e., a couple of weeks). While it is sometimes possible to settle debts at a fraction of what is owed through payments over time, one-time payments tend to enable lower settlements. Further, lump-sum payments remove the risk of default. The worst-case scenario for a debtor in settling his or her debts is to default on settlement payments. This is because the settlement agreements will typically state the settlement deal is terminated if you miss a payment (i.e., default). Then, the balance owed typically reverts back to 100% plus interest, less any amounts you paid for the settlement.
  • 3) Not all debts can be settled. Typically, only certain types of unsecured debt such as credit cards and medical bills can be settled. For most secured debts (ex., mortgage, car loan), you cannot settle the debt without losing the collateral. However, if you don’t pay a secured debt and the creditor repossesses the collateral, you can typically settle deficiency liability (i.e., amount owed on the debt minus the amount the creditor gets selling the collateral after repossession). Additionally, some unsecured debts can be difficult, if not impossible, to settle. For example, federal student loans are extremely difficult to settle because they can’t be discharged in bankruptcy. Taxes and other debts owed to the government (ex., SBA loans) have formal settlement procedures (for more information see Tax Resolution) which, like bankruptcy, will evaluate your assets and income to determine your ability to repay.

Risk of Being Sued and the Importance of Timing in Settling Debt

Debt settlement carries with it an inherent risk: being sued. Because settling debts requires you to be in default, there is always a risk that you will be sued while settling your debts. An unsecured creditor sues you so that it can get a judgment, which it can be use to garnish your wages or bank account or put a lien on your home. Generally, you can settle a debt even when you are sued but the amount you pay to settle tends to increase after you have been sued. To settle a debt after being sued, it is important to negotiate the settlement before the creditor is able to garnish your wages. Once your wages are being garnished, it becomes difficult, if not impossible, to settle. Timing is a key component of debt settlement. On the one hand, you must be far enough into default for the creditor to accept a fraction of the amount owed as settlement in full. On the other hand, missing payments to creditors means you are on the road to getting sued. While each creditor and each debt will be different, they tend to follow a similar curve.

Debt Settlement Versus Bankruptcy

Many people have preconceived notions of the pros and cons of bankruptcy and debt settlement. Many people want to settle debt to avoid the stigma of bankruptcy. And others believe bankruptcy is the best remedy for debt regardless of their assets and income. Wink & Wink can help you understand the reality of your options. And we encourage everyone to set aside their biases and focus on the most cost-effective debt relief option for their situation.

One common misconception is that settling debt is better for your credit than bankruptcy. This is not necessarily true. Because bankruptcy acts as a quick cleanse of your bad debt, it is possible to have a 700 plus credit score within 24 months and be eligible for a mortgage within 2 to 3 years of filing bankruptcy. On the other hand, debt settlement typically requires you to be in default on your debt for 12 to 24 months. While your credit will be better after you settle your debt, this period of default can mean that it takes longer to get to a 700 plus credit score when settling debt than it does when filing bankruptcy. In any case, your credit will recover after you resolve your debt in bankruptcy or through settlement. And Wink & Wink generally encourages people not to focus on the impact on their credit when choosing which form of debt relief is best for them because the most important thing is handling the debt issue. Credit will come back no matter which path is best for you.

While impact on your credit is typically not a relevant factor on choosing between bankruptcy and debt settlement, tax consequences can be very relevant in this decision. Debt forgiven through settlement is typically taxable. For example, if you pay $4,000 to settle a credit card balance of $10,000, the credit card lender will issue you a 1099 for $6,000 of taxable income. This is a key distinction from bankruptcy, where discharged debt is not taxable. You may be able to avoid the tax on debt forgiven through settlement if you were insolvent (i.e., your debts are worth more than your assets) when you settled the debt. Wink & Wink can help you estimate the total cost of bankruptcy as well as debt settlement, including tax consequences.

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The Value of Wink & Wink In Debt Settlement

Wink & Wink can help you settle your debt. Wink & Wink will manage the communications with your creditors so you aren’t inundated with collection calls and so that the message to the creditors is crafted toward getting you the best settlement possible. If you get sued, Wink & Wink can advise you on how to manage the lawsuit for settlement. Additionally, because of our experience in settling debts, Wink & Wink can advise you when to reject a settlement offer that is likely to get better and when to accept an offer that is likely to get worse if rejected. Finally, if your situation changes while you are attempting to settle your debts (ex., your income changes), Wink & Wink can help you re-evaluate your debt relief options, including bankruptcy. Contact us to schedule a FREE CONSULTATION.