After October 17, 2005, a lot of people are going to become interested in debt settlement as an alternative to bankruptcy. That's the date the new bankruptcy law goes into effect, and it means a rude awakening for many consumers seeking a fresh start in bankruptcy court.

It used to be that 7 out of 10 people filing personal bankruptcy were granted Chapter 7 status, where the unsecured debts are totally wiped away. That will change under the new rules. If your income is above the median for your state, or you can pay back at least $100 per month toward your debts, then you'll be turned down for Chapter 7. Instead, you'll be shifted into Chapter 13, where you pay back a portion of the debt over 3-5 years.

It gets worse. When the court calculates your allowable living expenses, it will use the approved IRS schedules, not your actual documented expenses. So even if you don't think you can pay $100 a month or more, the judge will probably disagree. Instead of a fresh start, many people will be faced with the grim reality of a harsh 5-year plan, on a court-mandated budget that forces them to adopt a much lower standard of living. That's where debt settlement starts to look pretty attractive.

Yes, I know debt settlement has its critics. I've criticized aspects of the industry myself. But what the critics don't seem to understand is that this approach is for people who would otherwise go bankrupt! Let's examine the three main complaints against debt settlement and see where the critics are missing the mark.

"Debt settlement has a negative impact on your credit score."

Wow. Big deal! Pretend it's two years from now. Would you rather have an A+ credit rating or be totally free of debt? Pick one please, because you can't have both. All debt reduction programs have a negative impact on credit scores. That's why only people who truly can't keep up with their bills should go into one of these programs. But it's pointless to worry about your credit while you're being crushed with debt. That's like worrying about how the yard looks after your house has burned down.

"You might have to pay taxes on the canceled portion of the debt."

I've always been amazed at how frequently this lame criticism is repeated in article after article. Yes, it's possible that you may need to pay taxes on forgiven debt balances, but the odds are against it. That's because the IRS allows insolvent taxpayers to exclude canceled debts. So unless you have a positive net worth, you probably won't need to pay taxes on your settlements. And even if you did, so what? You'd be paying taxes because you saved a bunch of money off your debts! And this is a problem?

"Collection activity will continue and you might get sued."

Yes, if you fall behind on your bills, your creditors will most certainly continue attempts to collect what's owed, and one or more of those creditors might sue you in civil court. But again, this criticism totally misses the mark. Collection activity is already a function of being in debt trouble. At least debt settlement allows the consumer to use the collection process to eliminate debt through negotiated compromises. Even lawsuits need not be cause for panic, since they can often be settled out of court. The only reason to allow a legal action to proceed to the point of wage garnishment, property lien, or bank levy is lack of financial resources with which to settle. And if that's the case, the debtor should be talking to a bankruptcy attorney anyway.

In contrast, let's look at some of the positives of debt settlement.

1. You can save $1,000s versus any other method of debt elimination (except for Chapter 7 bankruptcy, which will become difficult to accomplish after the new law takes effect).

2. You can get out of debt in 2-3 years, and much faster if there is some available home equity to work with. This is a lot better than 5 years in the financial boot camp of Chapter 13 bankruptcy, or 5-9 years in a credit counseling program.

3. You keep control over the process more than with any other approach.

4. You maintain personal privacy. With bankruptcy, your case file becomes a matter of public record, easily located via Internet search by future employers, landlords, or creditors.

5. You retain your dignity while working through your financial problems. Bankruptcy still feels like failure to a lot of people. Debt settlement represents an honest and ethical alternative to that extreme solution.

6. You can adjust your monthly funding into the settlement program up or down depending on real-world conditions in your financial life. If your income fluctuates from one month to the next, or you get hit with an unexpected expense, it won't torpedo the whole program. The built-in flexibility of debt settlement gives it a huge advantage over other options, all of which require a fixed monthly payment.

Once you're made the determination that debt settlement makes sense for your situation, you'll need to decide whether to go it alone or seek professional assistance. For people who aren't easily intimidated, there's no question that the do-it-yourself approach is the way to go. For others who can't handle the least bit of pressure or just want to focus their time and energy elsewhere, hiring a professional settlement company may be the correct choice.

If you do decide to take the do-it-yourself approach, follow these tips:

* Use a privacy manager on your telephone service to screen creditor calls so that you only speak to creditors when you're ready.

* Make sure you have a solid game plan for building up money to settle with, and set the funds aside in a separate bank account.

* Do not send settlement funds until you have the deal in writing. No exceptions!

* After paying the settlement, follow up to obtain a zero balance letter from the creditor, so you don't have bogus collection problems later on.

* Know your rights as a consumer by reading the free resource articles on debt, credit, and collections at the Federal Trade Commission website, (www.ftc.gov).

* Don't be intimidated or pressured into accepting a settlement deal that you can't handle.

Remember, thousands of people settle their own debts every year, without need for lawyers or bankruptcy. You can do it too if you're disciplined, determined, and prepared to ignore some of the crazy stuff that bill collectors say. When you're finally debt-free, you'll feel a lot better about having worked it out on your own. Good luck on your road to debt freedom!

Charles J. Phelan has been helping consumers become debt-free without bankruptcy since 1997. A former senior executive with one of the nation's largest debt management firms, he is the author of the Debt Elimination Success Seminar™, which provides comprehensive instruction in do-it-yourself debt settlement that saves $1,000s in fees.

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