Debt Settlement vs. Bankruptcy: Why Creditors Favor Settlement

Other than debt settlement, bankruptcy is an option to solving your debt situation.  Nonetheless, debt settlement be able to prevent a number of negative consequences. Chief among those consequences is the credit score problem that comes with a bankruptcy. Many lenders will not be willing to issue a loan to a borrower who has filed for bankruptcy in the past. Bankruptcy can also be very expensive and stressful. The good news: creditors may prefer settlement as well. Creditors also lose out when bankruptcy occurs. They will work with borrowers to help rectify the situation before the courts get involved.

#1 Expedite Settlement

Bankruptcy takes a very long time. It is not uncommon for some subordinate lenders, meaning those who have a secondary claim to an asset, to not receive funds for many years. Courts ensure that you, the borrower, pay off all your senior debts first. Tax debt is paid, then mortgage debt, then auto debt, and so on down the line of obligations. Paying each of these debts can take you a long time if you are currently in a financial crisis. Payment schedules can be extended for a decade, and by then creditors have lost any potential earnings to inflation. They would prefer to work out a structure to recover a smaller portion of the funds today than a larger portion of the funds over the next 5 to 10 years.

#2 Loss Mitigation

Loss mitigation is a term describing a general mindset about recovering debts. Creditors will have some losses when your debt goes into default. As a result, they prepare for a process where they do not try to gain a profit. Instead, they are simply trying to lose the smallest amount possible in the deal. If a debt goes to a bankruptcy judge, creditors are running the risk of that judge settling the debt for an amount small enough that they will lose more than they would like. In fact, some debts may be forgiven out right in bankruptcy if the borrower meets specific circumstances. A creditor, then, will be ready to talk when you offer to simply pay a portion of the debt up front and walk away without declaring bankruptcy.

#3 Expense of Repossession

Most people declaring bankruptcy have at least one asset that was used as collateral on a loan. Examples of collateralized loans include auto loans and mortgage loans. In both of these cases, lenders will have to repossess the asset then liquidate it to try to recover funds lost on the loan. It is rare for a lender to recover the entire sum needed to avoid a loss. The cost of holding the asset while the lender tries to sell it can be very high. Technically, a borrower would be responsible to cover this cost and the difference in the sale price versus the amount remaining on the loan. This is called a "recourse" loan. With bankruptcy, though, most courts will allow the remaining debt to be forgiven in exchange for the repossession, called a "non recourse" loan. This costs the lender money in the long run.