Credit counseling is a service that provides education and budgeting assistance to consumers to help them manage their personal finances and, if needed, a means of debt relief known as a debt management plan (commonly referred to as a “DMP”) to repay their unsecured credit card debt. The goal of credit counseling is to provide consumers with the tools they need to repay their debt in full and avoid more drastic solutions such as debt settlement or filing bankruptcy. This goal, i.e. the intent to repay the debt in full, is the fundamental difference between credit counseling and either debt settlement or filing bankruptcy, which do not provide for the full repayment of a consumer’s debt.

Ideally, a consumer that is struggling to repay their credit card accounts each month will receive information and assistance through credit counseling that will enable them to balance their budget and make the minimum monthly payments required by their creditors. In many cases, however, consumers are unable to balance their budget without lower credit card payments, which a debt management plan can provide.

Debt management plans are provided by creditors to consumers who obtain credit counseling and need assistance in repaying their credit cards as a result of an unforeseen hardship. Each of the major credit card companies has their own specific criteria for an account holder to be eligible for their debt management plan benefits, but for the most part, they all share the following in common:

• Consumer must have a financial hardship preventing them from paying contracted minimum payments on account.
• Consumer must receive budget counseling from an accredited credit counseling agency and be able to afford debt management plan payment.
• Debt management plan payment must provide for payoff of account balance in 5 years or less.
• All accounts enrolled in the debt management plan are closed and consumer must refrain from incurring any new credit card debt.

Credit counseling agencies offering debt management plans to consumers are responsible for designing plans and sending proposals to the consumer’s creditors for benefits in accordance with each creditor’s criteria. Many creditors require that a balanced budget for the consumer be submitted with the proposals reflecting the consumer’s ability to make the monthly debt management plan payment. Assuming the proposals are compliant with the creditor’s criteria, they are accepted and the debt management plan benefits are extended by the creditor to the consumer. If a proposal received by a creditor is deficient in any manner, the creditor will notify the credit counseling agency to correct the deficiency, if possible, and resubmit another proposal.

Debt management plans are designed to be beneficial to both consumers and creditors. The consumer is provided a repayment plan that they can afford and the creditor receives repayment of the principal amount of the debt plus, in most cases, a fair interest rate. Specific benefits to consumers vary among credit card companies, but generally include:

• Consolidation of individual monthly payments to creditors into one monthly payment to credit counseling agency.
• Reduced interest rates.
• Lower monthly payments.
• Stopping of collection efforts, including telephone calls.
• Elimination of past due fees and over-limit fees.
• Reporting of accounts to major credit bureaus as current.

The most common benefit of a debt management plan is the consolidation of multiple monthly payments to a consumer’s individual creditors into one lower monthly payment to the credit counseling agency. Many people refer to credit counseling and debt management plans as “debt consolidation” for this reason. The credit counseling agency will hold the consolidated payment in a federally insured trust account until the funds clear and then disburse individual payments to the consumer’s creditors as required. As each account enrolled in the debt management plan is paid in full, the payment for that account is redirected to another enrolled account until all accounts are paid in full. Consequently, the consolidated debt management plan payment generally remains constant throughout the plan term.

The consolidated debt management plan payment, including the credit counseling agency service fee, is usually less than the sum of the individual payments previously being paid by the consumer as a result of interest rate reductions granted by the creditors.

Interest rate reductions offered by creditors vary based on each creditor’s policies and the particular account history the consumer has with the creditor. The length of time a credit card account has been open, the balance and nature of transactions on the account, the consumer’s payment history on the account, and the financial hardship reported by the consumer may all factor into the reduced interest rate a creditor is willing to extend under a debt management plan. Annual interest rates on debt management plan accounts generally average between 5% and 10%. Consumers entering a debt management plan who are, or have been, past due in the payment of their credit card accounts are often being charged default interest rates of 29% or higher, so the interest rate reduction can be a significant benefit.

Creditors generally require that all accounts enrolled in a debt management plan be paid in full within 5 years. Consequently, the monthly debt management plan payments must be set high enough to pay all the enrolled account balances plus the interest within such period of time. For this reason, monthly debt management plan payments, including credit counseling agency fees, typically average 2.5% or more of the total enrolled account balances at the inception of the plan. See adjacent table for estimated DMP payments on specified total debt amounts.

The most important benefit for many consumers who enroll past due credit card accounts in a debt management plan is that the creditors stop their efforts to collect the debt, including telephone calls, threatening letters and lawsuits. Credit counseling agencies managing debt management plans for consumers are expected to help consumers manage their budgets so the monthly DMP payments are not missed. Accordingly, collection efforts should not be needed. Creditors also stop assessing past due and over limit fees on delinquent accounts enrolled in a debt management plan. Of course, if a consumer fails to make their monthly debt management plan payments, the creditor collection efforts and fees will resume.

Another benefit of debt management plans extended by many creditors is the process of bringing delinquent accounts current. This is often called "reaging" an account. This usually occurs after the first two or three payments through the debt management program are made on time. For example, a consumer with an account which has not been paid in two months might be reported by their creditor to the major credit bureaus as 60 days past due. After receiving three consecutive monthly payments through a debt management plan, the creditor may re-age the account to reflect a current status. This process does not eliminate the prior delinquencies on the credit bureau reports. It merely gives a fresh start and an opportunity for the consumer to begin building a positive credit history.

In order to assist consumers with the consolidation of their debt payments into one monthly payment, many credit counseling agencies will also allow unsecured debts other than credit cards to be included in a consumer’s debt management plan, such as collection accounts, medical bills and personal loans. However, the debt management plan benefits available for these types of accounts are usually limited. For example, if a credit card account has already been charged off by the original creditor and sold to a collection agency, interest on the account is no longer accruing so the benefit of a reduced interest rate is not available. Many collection agencies will, however, accept payments from a credit counseling agency and stop their attempts to collect the debt directly from the consumer.

Debt management plans are only offered by creditors through accredited credit counseling agencies that are licensed or otherwise authorized to provide such services in the state in which consumer resides. Credit counseling agencies may be organized as for-profit or non-profit entities. Regardless of their for-profit or non-profit status, fees charged by credit counseling agencies for debt management plan services are regulated by the creditors and most states. Some non-profit credit counseling agencies are also recognized as tax exempt charities under IRS Code Section 501(c)(3). These charitable organizations provide consumers ongoing education and counseling as part of their mission, and may receive voluntary contributions from some creditors to help them fund their programs.

Consumers should consider a debt management plan if:

Consumers should NOT consider a debt management plan if:

1. All credit card accounts enrolled in a DMP will be closed and consumer may not open new credit card accounts or unsecured lines of credit during the plan term.
2. Although participation in a DMP is not a factor in determining consumer FICO scores, it will be reported by creditors to the major credit bureaus and may affect a lender’s decision to extend credit.
3. If a consumer misses monthly DMP payments, the creditors may drop them from plan, increase interest rates and payments, and resume their collection efforts and fees.
4. Consumers may payoff the enrolled accounts at anytime and terminate the DMP with no penalty.

Debt settlement, also known as debt negotiation, is a means of debt relief in which the consumer and creditor agree on a reduced balance that will be regarded as payment in full. Debt settlement is only possible for unsecured debts such as credit cards and medical bills where the creditor is unable to seize or lien assets of the consumer to satisfy the debt. Unsecured creditors offer settlements of debts for less than the amount owed if they believe the consumer is unable to repay the full balance and the settlement will avoid greater costs or losses, e.g. if the consumer files bankruptcy.

Debt settlement is an alternative to bankruptcy for consumers who are unable to pay their contracted minimum monthly payments or afford debt management plan payments through a credit counseling agency. Consumers opting for debt settlement avoid the stigma and intrusive court-mandated controls of bankruptcy while still lowering their debt balances. At the same time, their creditors recover a portion of their loans and avoid the risk of the consumer filing bankruptcy where they could lose the entire amount owed.

Essentially, debt settlement is the process of negotiating with creditors to reduce a consumer’s debts in exchange for lump sum payments. A successful settlement occurs when a creditor agrees to forgive a percentage of the total account balance owed by a consumer for a lump sum amount. Settlements may be negotiated by consumers themselves or by a debt settlement company or attorney hired by consumers to represent them.

Two key elements to successfully negotiating settlements with creditors are:

1. The creditors belief that consumer cannot afford to pay the full balances.
2. The availability of funds to make lump sum payments.

The first key element to negotiating debt settlements is the creditors’ belief and understanding that the consumer is unable to pay the debt as agreed. As long as a consumer continues to make minimum monthly payments, creditors will not negotiate reduced balances, because timely payments indicate the consumer’s ability to pay the full balances as contracted.1 However, if a consumer is delinquent in making the required payments to all their creditors and the creditors have been unsuccessful in their efforts to collect funds from the consumer, the creditors may be willing to accept a settlement for a lesser amount. In fact, the more delinquent the consumer is in repaying a debt; the more likely it is that the creditor will accept an even lesser amount. This applies particularly to debts that have already been charged off by the original creditors and sold to third party collection agencies for less than the amounts owed.

1This is true even if minimum payments are being paid to only one or a couple creditors and not to them all, because the creditors not getting paid will believe the consumer is able to pay them as well, or alternatively, pay them instead of the other creditors.

The second key element to negotiating debt settlements is the availability of funds to make lump sum payments to the creditors. This requirement is difficult and usually impossible for consumers who have experienced a financial hardship and are unable to make their required monthly debt payments. In such cases, a debt settlement plan may be established in which a specified amount is saved by the consumer each month until sufficient funds have accumulated to make lump sum settlement offers to the creditors. Consumers in a debt settlement plan generally stop paying their creditors directly in order to save sufficient funds for the future settlement of these debts, which also supports the first key element, i.e. the consumer’s inability to make monthly payments and pay their debt in full.2

2It is important to note that when consumers stop paying their creditors, their creditors will increase their efforts to collect the debt as long as it remains unpaid, including increased collection calls and possible litigation. See discussion of Creditor Collection Efforts that follows.

Debt settlement plans are offered by debt settlement companies and attorneys to provide consumers a structured program to payoff their unsecured debts in a specified period of time. However, since the lump sum amounts that a consumer’s debts may be settled for is unknown at the time debt settlement plans are designed, the time required to accumulate sufficient funds to settle the included plan debts is only an estimate. In addition, since debt settlement plans are not controlled by creditors like debt management plans are through credit counseling agencies, debt settlement providers are free to establish their own plan terms and estimates. Most debt settlement plans offered by providers, however, share the following characteristics:

• Specify flat monthly payments equal to 1.4% to 1.8% of total debt for a period of time not exceeding 48 months.
• Require total debt of at least $10,000 to be included, with individual account balances of at least $500.
• Provide option for consumers to save accumulated settlement funds in third party or attorney trust accounts.
• Provide negotiation of settlement amounts with creditors when sufficient funds have been accumulated.
• Estimate settlements at 40% to 50% of the balances owed.

Unlike debt management plan payments, monthly payments for debt settlement plans are not fixed by creditors and therefore, may vary greatly among debt settlement providers. Most providers will make the monthly debt settlement plan payments as affordable as possible for the consumer within some specified maximum term limits, e.g. 48 months. This allows debt settlement plans to be designed in a manner that best meets the finances and goals of the particular consumer. Higher payments will accumulate the required settlement funds at a faster rate and shorten the plan term, whereas lower payments will accumulate the required settlement funds at a slower rate and lengthen the plan term.3

Also, since debt settlement plans are designed to payoff debts at less than the full balances owed, debt settlement plan payments are generally much lower (1.4% to 1.8% of total debt) than debt management plan payments (average 2.5% of total debt) for the same debts. See adjacent chart for payment comparison.

3Debt settlement plan payments are based on an estimate of what the debts will be settled for at some time in the future. Consequently, the initial plan term quoted by providers is merely an estimate, i.e. the plan will actually last as long as required to accumulate sufficient funds to settle the debts with lump sum payments.

In order to make debt settlement plans cost effective, most providers require a minimum of $10,000 in total debt balances be included in plan. This minimum amount of debt generally allows sufficient savings to be generated when debts are settled for the plan to be beneficial to the consumer.

Similarly, most Providers will not accept account balances that are less than $500, because the savings generated from the settlement of such accounts is usually minimal and not cost effective for consumer.

Debt settlement plans only work if a) consumers fund the monthly savings amounts specified, and b) do not spend the accumulated funds on other things. Debt settlement providers typically offer third party account services to consumers for this purpose. These account services will setup automatic payment withdrawals from the consumers’ bank accounts each month, hold the funds in designated trust accounts on behalf of consumers, and disburse settlement payments to creditors as instructed. The automatic payment withdrawals assist consumers with managing their budgeted finances and, since the funds are not so readily available, helps prevent consumers from withdrawing the funds to spend on other things. Consumers who elect to hold the funds themselves in accounts that are readily accessible to them must be able to maintain the required discipline to fund their accounts each month with the plan specified savings amounts and not withdraw the accumulated funds for other purposes.

Attorneys who provide debt settlement services may also offer to hold a consumer’s accumulated savings funds in an attorney trust account. This option provides the consumer the management benefits of third party account services with the added benefit of protecting the funds from the consumer’s creditors. 4

4 In some States creditors may be able to file lawsuits against consumers to collect the debt owed and obtain judgments allowing them to lien a consumer’s bank accounts. Creditors are not able to lien consumer funds held in an attorney trust account.

Debt settlement providers will negotiate settlements with the consumers’ creditors during the term of the debt settlement plan whenever sufficient funds have been accumulated to make bona fide settlement offers. Settlement providers have established relationships with many creditors and are knowledgeable of their settlement policies and procedures. There is no specific order or amount that dictates when consumers’ plan debts will be settled. The goal for every debt settlement provider should be to settle debts when it is most advantageous for the consumer. Sometimes this will be when the greatest savings can be achieved for consumer and sometimes this will be when creditor demands require payment to stop legal action to collect the debt.

Since settlements require lump sum payments, they are generally settled one at a time. Settlement providers may, however, be able to arrange for negotiated settlement amounts to be paid in 2 or more installments, which can expedite the repayment of some or all of a consumer’s accounts. After the first debt included in a plan is settled, the settlement provider typically needs to wait until additional settlement funds are accumulated in the consumer’s savings account before another debt can be settled, and so on. When the last debt is settled, the plan ends.

Debt settlement plans are typically designed to provide accumulated savings to make lump sum settlement offers to creditors equal to 40% to 50% of the debt balances at the inception of the plan. However, these percentages are merely estimates and may or may not provide sufficient funds to settle all the debts in the plan.

The percentages utilized by debt settlement providers when designing plans should be representative of their historical experience settling debts, but they cannot be relied on to accurately predict the actual settlements that will be obtained for the consumers. What any given creditor is willing to accept to settle a debt is subject to many variables, including, but not limited to, their history with the particular consumer, their overall debt portfolio and performance, the economy, and like a new car salesman, if it is the end of the month and they need to meet their monthly settlement goals.

Creditors have a legitimate right to pursue collection of the debts owed to them and, in most cases, will continue their collection activities until the debts are paid or otherwise satisfied. When a consumer stops making monthly payments to their creditors and instead, starts saving funds to settle the debts in the future pursuant to a debt settlement plan, it is likely that the creditors will increase their collection efforts. For the consumer, that means increased telephone calls, threatening letters and possibly, legal action.

This increased level of collection efforts represents a major difference between debt settlement plans and the other debt relief options discussed in this course, i.e. debt management plans and bankruptcy. Under debt management plans, the creditors continue to receive monthly payments in amounts they have approved and therefore, suspend all collection efforts. When consumers file bankruptcy, the creditors are prohibited by the court from conducting any further collection activities.

Collection calls may come from collectors representing the original creditor or, if the account has been charged-off and sold to a collection agency, from third party debt collectors. Third party debt collectors, specifically, are governed by the Fair Debt Collection Practices Act (FDCPA), which was passed for the purpose of eliminating abusive practices in the collection of consumer debts. The FDCPA creates guidelines under which debt collectors may conduct business, defines rights of consumers involved with debt collectors, and prescribes penalties and remedies for violations of the Act. Consumers may enforce their rights under the FDCPA to stop or limit the collection calls, e.g. disallowing any calls to consumer’s place of work. However, it is important to note that the FDCPA does not apply to original creditors.

Many factors will determine if and when a creditor decides to take legal action against a consumer, including, among other things, the amount of the debt, the consumer’s state of residence and applicable laws, their assessment of collectability and the consumer’s ability to pay, their internal policies, and their experience in trying to collect the debt from the consumer. If a creditor decides to take legal action against a consumer it must be done in writing and the consumer must be properly served a summons or complaint. There is no such thing as verbal notice of legal action.

Consumers who are sued by their creditors must answer the summons or complaint, or otherwise contact the creditor and make acceptable arrangements to satisfy the debt. Ignoring the lawsuit will likely result in the creditor being awarded a default judgment against the consumer and, if permissible in the consumer’s state of residence, asking the court to issue orders to garnish the consumer’s wages or bank accounts.

In the event of legal action, most debt settlement companies and attorneys providing debt settlement plans will make an attempt to expedite the settlement negotiations with the creditor and reach an amicable resolution to stop the lawsuit. If the consumer does not have sufficient savings funds available at such time to settle the debt, the creditor may accept monthly payment arrangements to payoff the debt over an acceptable period of time. If the debt settlement provider is unable to offer a lump-sum settlement or acceptable payment arrangement to stop the lawsuit, the consumer will need to consider other alternatives, such as defending the legal action in court, filing for bankruptcy protection, or even allowing the creditor to obtain a judgment. 5

5 A judgment does not guarantee a creditor payment. It merely gives them the right to use the means permitted by law to try and collect. Depending on the consumer’s state of residence and financial situation, the creditor may have no more ability to collect the judgment than it had to collect the original unsecured debt. If a creditor is not been able to collect on a judgment, a settlement provider may be able to negotiate a settlement of the judgment for a lesser amount. Consumers facing litigation and the possibility of a judgment should seek the advice of an attorney.

Once a consumer stops paying their creditors the monthly minimum payments required by their credit agreements, the creditors report the accounts as delinquent to the three major credit bureaus. This delinquent reporting will continue until such time the accounts are charged-off by the original creditors and sold to a third party collection company (usually after accounts are 6 months delinquent). When the accounts are sold, the third parties who purchase the accounts will then start reporting the same accounts as collection accounts. The delinquent reporting by the original creditors and the reporting of the collection accounts will have a severe negative effect on the consumer’s credit scores and rating.

When a consumer’s accounts are settled or otherwise satisfied, the historical delinquencies and collection activity will remain on the consumer’s credit reports unless the information reported is inaccurate and the consumer is able to have the reporting removed or corrected by exercising rights granted under the Fair Credit Reporting Act. If the delinquencies and collection accounts are not removed, the passage of time will lessen the impact of these negative marks on the consumers’ credit scores.

Debt settlement plans should only be offered by debt settlement companies or attorneys that are licensed or otherwise authorized to provide such services in the state in which a consumer resides. Many states, however, do not permit debt settlement companies to provide such services to their residents. A consumer desiring debt settlement services in such states will need to obtain them from a licensed attorney in that state. Attorneys providing debt settlement services are also able to provide consumers legal advice about their debts and other matters the consumers may need assistance with, including creditor lawsuits and bankruptcy protection.

Debt settlement companies may be organized as for-profit or non-profit entities. Regardless of their organization status, fees charged by debt settlement companies are regulated by most of the states that permit debt settlement services. Attorneys are regulated by their respective state bars and are generally exempt from state fee regulations. Both debt settlement companies and attorneys who contract consumers over interstate telephone calls, however, are subject to fee restrictions included in the Telemarketing Sales Rule as amended by the U.S Federal Trade Commission in 2010.

It is possible for a consumer to establish their own debt settlement plan and imitate the methods of professional debt settlement providers. The most obvious benefit of doing so would be to save the fees that would have to be paid for such services. Without having to pay any fees, a disciplined consumer could save the funds needed to settle debts with their creditors quicker and accelerate the payoff of all their debts. Of course, there are some potential negatives associated with a do-it-yourself option, including the following:

• Consumer may have a difficult time reaching decision makers and some creditors may not settle directly with consumers at all.
• Settlement rates obtained by consumer may not be as good as rates obtained by debt settlement providers who are familiar with creditor policies and can offer bulk settlements.
• Consumer will not have any help or support during plan, particularly if creditor takes legal action to collect debt.
• Unfamiliarity of the settlement process and agreements can be intimidating and mistakes can be made by consumer.

Consumers should consider a debt settlement plan if:

• They have a financial hardship that prevents them from paying the minimum monthly credit card payments required by their creditors and they cannot afford a debt management plan.
• They have a source of income that allows them to save funds each month equal to approximately 1.6% of the total debt balances to be settled.
• They understand the negative effect that not paying their creditors will have on their credit scores and rating.
• They understand that their creditors will increase their efforts to collect the debt, including possible legal action.
• They want to avoid filing bankruptcy

Consumers should NOT consider a debt settlement plan if:

• They require the continued availability and use of credit during the plan term.
• They cannot afford to save a sufficient amount of funds to settle their debts within a reasonable period of time (48 months or less).
• Their employment position requires an acceptable credit rating, e.g. for security clearance.
• They are not committed to the plan and willing to handle increased collection efforts by their creditors.

1. Debt settlement plan payments are not paid to creditors; they are saved in a separate account until sufficient funds have been accumulated to make lump-sum settlement offers to the creditors.
2. Debt settlement plan payments and terms are designed based on estimates; plans will need to be funded until such time sufficient funds are accumulated to settle all the included debts and pay associated provider fees.
3. Not paying creditor accounts may a) negatively affect a consumer’s credit worthiness, b) result in increased collection efforts by the creditors, including possible legal action, and c) increase the amount the consumer owes due to late fees and interest.
4. The U.S. Internal Revenue Service considers forgiven or canceled debt as income. Consequently, Creditors are required by law to report to the IRS on 1099-C forms any settlements that result in savings to the consumer of $600 or more. Consumers must report the amount of debt forgiven as income on their federal income tax returns, unless an available exclusion applies. Consumers who receive a Form 1099-C reporting forgiveness of debt income should consult their tax advisor.

Bankruptcy is a federal court procedure that grants debt relief and protection to consumers that are having difficulty paying, or are totally unable to pay, their unsecured creditors. The Bankruptcy Code, enacted by the U.S Congress in 1978 and amended several times since, is the uniform federal law that governs all bankruptcy cases. One of the primary purposes of the Bankruptcy Code is to relieve the honest consumer from the weight of oppressive indebtedness and to provide the consumer with a fresh start.

Bankruptcy is considered by many consumers to be the last resort to debt relief when other alternatives, such as credit counseling and debt settlement, are not viable options. Consumers opting for bankruptcy are protected from any further collection attempts by their creditors of the debts discharged or satisfied through a payment plan.

As previously noted, bankruptcy is a procedure that encompasses the filing of forms and documents by a consumer in a bankruptcy court in accordance with federal and local rules. Bankruptcy filings are to be done by consumers in the court located in the judicial district in which they reside and are eligible to file. Each state has one or more districts comprising a total of 90 bankruptcy districts across the country, and each district has a bankruptcy court. Each court is governed by a bankruptcy judge who has decision making authority over all bankruptcy case matters, including eligibility to file and whether debts will be discharged in whole or in part.

Bankruptcy is mostly an administrative process that could take several months to complete. Basically, it starts when a consumer files a bankruptcy petition with the court. The petition provides information to the court about the consumer, including contact information, financial details and creditor information. The filing of the petition often starts something called an automatic stay. While the court is considering the bankruptcy case, the automatic stay generally prevents collections and other debt actions from proceeding. The bankruptcy process is carried out by a trustee that is appointed by the court to oversee the case. Typically, most of the process is conducted away from the court and the only time a consumer must appear is at a meeting of the creditors in the trustee’s office. Following successful bankruptcy proceedings, the consumer’s debts will be discharged in whole or in part, depending on the type of bankruptcy protection granted.

There are six types of bankruptcy cases provided under the Bankruptcy Code, which are traditionally referred to by the chapters in the Bankruptcy Code that describe them. The two chapters under which most consumers may seek protection are Chapter 7 and Chapter 13.

Chapter 7 bankruptcy is also known as liquidation. In Chapter 7 bankruptcy, a trustee collects the non-exempt property of the consumer, converts the property to cash, and distributes the cash to the creditors. Once the Chapter 7 liquidation process has been completed, the consumer is totally discharged from their unsecured debts. Typically, Chapter 7 bankruptcy is sought by individuals with minimal, if any, assets. In these instances, the bankruptcy trustee has no assets to liquidate, but the consumer is still relieved of the responsibility of repaying their debts.

Chapters 13 bankruptcy allows for consumer rehabilitation. In Chapter 13 bankruptcy, the consumer generally retains their assets and property, but makes payments to creditors through the trustee pursuant to a court approved plan. Chapter 13 plans require the repayment of some or all of the consumer’s debt over a 5 year period based on the consumer’s disposable income.

There are two tests which determine whether or not a consumer qualifies to file for bankruptcy relief under Chapter 7 of the Bankruptcy Code:

• Median Income Test
• Means Test

The median income test is to determine if a consumer’s current monthly income is more than the median income of at least one half of the other residents residing in the consumer’s state. This calculation is based on the consumer’s gross income for the preceding 6 month period.

The means test is to determine if the consumer’s current monthly income reduced by IRS and other allowed monthly expenses for a family of the same size, exceeds a certain amount that would allow consumer to repay some of their debt.

If a consumer passes the Median Income Test, i.e. their current monthly income is less than the median income of other state residents, they are eligible to file under Chapter 7. If the consumer fails the Median Income test, they must pass the Means Test in order to file under Chapter 7, i.e. their current monthly income less allowed expenses must not be sufficient to repay any of the consumer’s debts.

In the event a consumer files for Chapter 7 bankruptcy and fails the required tests, the bankruptcy court may consider the filing abusive and either force the consumer into a Chapter 13 bankruptcy or dismiss the case.

Within 6 months before filing for bankruptcy relief under either Chapter 7 or Chapter 13, consumers must obtain budget counseling from a 501(c)(3) credit counseling agency specifically approved to provide such counseling by the U.S. Department of Justice. The counseling session is designed to analyze the consumer’s budget and assess whether or not a credit counseling program may provide the necessary assistance to help the consumer avoid the need to file bankruptcy. Consumer’s who obtain the required counseling do not need to enter a credit counseling program in order to file for bankruptcy; they just need to provide a certificate to the bankruptcy court evidencing that they were counseled.

After a consumer files for bankruptcy relief under Chapter 7 or Chapter 13, they must complete a personal financial management course that has been approved by the U.S. Department of Justice before the bankruptcy proceedings can be completed. The approved courses are designed to help the consumer identify and correct the mistakes that led them to file bankruptcy. The consumer must provide a certificate to the court evidencing their completion of the course.

Either filing may make credit less available to the consumer or only available on less favorable terms; although high debt can have the same effect, especially if it is delinquent. The negative aspect of the bankruptcy reporting must be balanced against the removal of actual debt from the consumer's record by the bankruptcy, which tends to improve creditworthiness. Consumer credit and creditworthiness is very complex, however, and the future ability of a consumer who files bankruptcy to obtain credit is dependent on multiple factors and difficult to predict.

Similar to debt settlement, it is possible for a consumer to file for bankruptcy without the assistance of an attorney. The most obvious benefit of doing so again would be to save the fees that would have to be paid for such services.1 Bankruptcy forms, templates and software are available for consumer’s to use to prepare and file their own bankruptcy petition. There are also non-attorney petition preparers who provide such services. It is important to note, however, that these do-it-yourself options do not guarantee compliance with all applicable laws, or assure that maximum advantage will be taken of exemptions.

A bankruptcy attorney can advise the consumer on when the best time to file is, whether they qualify for a Chapter 7 or need to file a Chapter 13, ensure that all requirements are fulfilled so that the bankruptcy will go smoothly, and whether the consumer's assets will be safe if they file. With expanded requirements of the BAPCPA bankruptcy act of 2005, filing a personal Chapter 7 bankruptcy is complicated. Many attorneys that used to practice bankruptcy in addition to their other fields, stopped doing so due to the additional requirements, liability and work involved.

1 Fees that an attorney may charge for a bankruptcy filing are limited by federal and state rules and must be approved by the bankruptcy court. Typical fees for an individual consumer filing bankruptcy are $1,700 for a Chapter 7 and $3,200 for a Chapter 13, but may vary significantly based on where consumer lives. Joint filings will cost more. Consumers filing bankruptcy must also pay court filing fees of approximately $300.

Consumers should consider bankruptcy if:

• They are unable to pay their debt obligations and other alternatives, such as credit counseling and debt settlement, do not provide enough help.
• Their liabilities exceed their assets making them insolvent.
• They understand the negative long-lasting effect that bankruptcy will have on their creditworthiness.

Consumers should NOT consider bankruptcy if:

• They have sufficient income and assets to pay their debts.
• They do not have any nonexempt assets or income, i.e. there is nothing for their creditors to take.
• They filed Chapter 7 within the previous 7 years or Chapter 13 within the last 6 years making them ineligible.

1. Consumers must be able to pass a Median Income Test and a Means Test to file and obtain Chapter 7 bankruptcy relief and a discharge of their debts. Consumers not qualifying for Chapter 7 may be forced to repay some or all of their debt through a Chapter 13 bankruptcy.
2. A Chapter 7 bankruptcy will be reported on the consumer’s credit report for 10 years and a Chapter 13 bankruptcy will be reported for 7 years.
3. Bankruptcy will have a severe negative affect on a consumer’s creditworthiness and make new credit difficult or more costly to obtain.
4. Bankruptcy can be a very emotional distressful event that disrupts a consumer’s personal life, as well as their finances.