Compare and Contrast: Debt Consolidation vs Bankruptcy
If you find yourself in this situation, you may be wondering what options are available to you. Many people are torn between debt consolidation vs. bankruptcy.
These are two very different debt management strategies, and each contains varying levels of complexity. Ultimately, the one that will be right for you will depend on your financial situation and desired outcome.
What Is Debt Consolidation?
One of the things that can make debt so unmanageable is attempting to pay off multiple loans. This is especially true if you have several high-interest credit cards you’re trying to pay off.
You may have high balances on each of them, and so the interest continues to add up month after month. But since your attention is split, you’re never able to make significant progress on any of them.
If you find yourself in this situation, debt consolidation could be a good option for you. With debt consolidation, you take out a new, larger loan and use that money to pay off your outstanding debts. Now, instead of multiple outstanding debts, you can focus your attention on making a single monthly payment.
There are many different ways you can pursue debt consolidation. If you can find a credit card offering a 0 percent introductory APR, you can use a balance transfer card. Or you could take out a low-cost personal loan or take out a home equity line of credit (HELOC).
Benefits of Debt Consolidation
Here are some of the biggest benefits of debt consolidation:
- Streamline your monthly payments: Trying to pay down multiple loans and credit cards can be overwhelming. Debt consolidation will streamline your monthly payments and could make it easier for you to pay down your debt quicker.
- Pay less in interest: If you have multiple credit cards you’re trying to pay off, then consolidating that debt with a HELOC or personal loan could save you a lot of money in interest.
- Improve your credit score: If all your credit cards are maxed out, then your credit utilization rate is probably very high. If you pay off these balances with a low-interest personal loan, this will lower your credit utilization rate and could improve your credit score.
Disadvantages of Debt Consolidation
Debt consolidation will only help you if you’re committed to paying off your credit cards and staying out of debt. Otherwise, you may pay down your balances and then become tempted to rack them up all over again. This is how many people find themselves in a cycle of debt they’re unable to break free from.
What Is Bankruptcy?
If you find yourself in a position where you know there’s no way for you to repay your debt, you might consider filing for bankruptcy. Bankruptcy is a form of federal protection for borrowers who are unable to repay their debt.
When you file for bankruptcy, you can choose to file for either Chapter 7 or Chapter 13. Chapter 7 is often referred to as liquidation, and it involves selling off many of your assets to repay your creditors.
Under the law, any of your assets that aren’t exempt can be sold off to repay your outstanding debt. Most of your eligible debts will be discharged.
In comparison, when you file a Chapter 13 bankruptcy, you’ll receive a court-approved plan that will allow you to repay your debts in three to five years. Once the repayment period is up, any remaining debt will be discharged.
Benefits of Bankruptcy
Here are some of the biggest advantages to consider before filing for bankruptcy:
- Stop getting harassed by creditors: If you’ve accumulated debt that you’re unable to repay, then odds are you’re getting contacted frequently by creditors. This can be overwhelming and stressful, and filing for bankruptcy can take away some of this pressure.
- Clear away your debt: If you file for bankruptcy, you’ll likely get rid of all your outstanding debt. The thought of wiping away your outstanding debt is appealing for anyone who’s struggling to make their monthly payments.
- You can begin rebuilding your financial future: If irresponsible spending is what got you into debt in the first place, then filing for bankruptcy could serve as a clean slate. It can give you a chance to start over and build a new financial future.
Disadvantages of Bankruptcy
All that being said, bankruptcy can take a serious toll on you both mentally and financially. The process is very long and stressful, and you may have to hire a lawyer to assist you.
Plus, your credit score will take a hit, and the bankruptcy will stay on your credit report for a long time. If you file for Chapter 7, it’ll stay on your credit report for 10 years. Chapter 11 will remain on your credit report for seven years.
In Favor of Working With Debt Settlement Companies
If debt consolidation isn’t the right option for you, but filing for bankruptcy feels too extreme, there is a third option. You could consider working with a debt settlement company.
A debt settlement company will work with your creditors on your behalf to try to reduce your outstanding debt. These third-party companies are also sometimes referred to as debt relief companies.
When you work with a debt settlement company, you’ll stop making your monthly payments on your debt. Instead, you’ll begin saving that money in a separate account toward one lump sum payment.
Once the debt settlement company reaches an agreement with your creditors, you’ll make one lower lump sum payment to settle the debt. Ideally, you’ll be able to pay less than what you owe and resolve your debt in the process.
If you’re debating between debt settlement vs. bankruptcy, there are a couple of things to keep in mind. First, you should do your homework on any debt relief company you choose to work with, so you don’t fall for a scam.
Lastly, remember that there’s no guarantee that the company will come to an agreement with your creditors. So, if you’re looking for guarantee you’ll get rid of your debt, bankruptcy may be the better choice.
Frequently Asked Questions
What is debt consolidation?
Debt consolidation takes your outstanding debt and rolls it into a single, larger loan. This allows you to streamline your monthly payments and pay less interest over time.
What is bankruptcy?
Bankruptcy is federal protection for borrowers who are unable to repay their debt. If you file a Chapter 7 bankruptcy, your eligible assets will be liquidated to repay your creditors. With Chapter 11, you’ll repay your creditors over three to five years, and then any remaining debt is discharged.
What is a debt settlement company?
A debt settlement company negotiates with your creditors on your behalf. They’ll attempt to negotiate one large lump sum payment that is less than what you currently owe.
Debt consolidation vs. bankruptcy: what’s the right choice?
Bankruptcy is for borrowers who are unable to repay their outstanding debt. If you’re able to repay your debt, but just hoping to simplify your monthly payments, then debt consolidation is the better choice.
Debt relief vs. bankruptcy: what’s the right choice?
Both debt settlement and bankruptcy are going to affect your credit significantly, and both are going to be long, drawn-out processes. If you feel like bankruptcy is too extreme and you want to try to negotiate a lower payment, then debt relief could be the right choice.
Still, keep in mind, that there’s no guarantee the company will be able to negotiate a lower payment for you.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.