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Debt Consolidation or Bankruptcy?
By Kristopher Kane MONEY RESEARCH COLLECTIVE
More American households owe creditors now than at any other time in history, and many people struggle with overwhelming debt. If you want to get your debt under control, you have options, including debt consolidation, credit card refinancing or even bankruptcy. If you’re debating debt consolidation or bankruptcy, there are a few essential things to know before deciding between the two.
We break down the pros and cons of both debt consolidation and bankruptcy so you can decide which is better for you.
Which is right for you: Debt consolidation or bankruptcy?
Debt consolidation and bankruptcy are conventional options for those struggling with too much debt. Debt consolidation involves combining your debts to one new loan with better terms than you had with your previous loans. On the other hand, bankruptcy absolves some or all of your debt, but it damages your credit score and could involve losing your assets.
Debt consolidation is usually preferred if attainable. However, the best choice for any particular circumstance depends on several important factors, such as the total amount of debt owed, the type of debt and other specific financial details. It’s essential to understand the differences thoroughly.
What is debt consolidation?
Pros
- Debt consolidation greatly simplifies financial tracking and planning
- It typically reduces the total interest rate across multiple debts
- Debt consolidation leads to improved credit scores
- It lowers existing monthly debt payments
Cons
- You are still legally liable for the total amount of your debt
- Consolidation can increase the time required to pay off all debt
- Those with poor credit will find it challenging to qualify for loans
- It relies on the debtor being able to maintain regular consolidation loan payments
- It temporarily affects your credit score since you open a new loan
Debt consolidation is a financial tool used to combine multiple debts into one. These debts, such as credit card debt, medical bills and personal loans, are combined into a single debt consolidation loan with a lower interest rate and monthly payment.
It’s a good option for those who can still make payments but wish to reduce their debt. One of the most significant advantages of debt consolidation is that it can reduce the total interest rate on your combined debts. By consolidating all your debts into one loan, you have a lower monthly payment and will generally save money in the long run.
Debt consolidation can also help simplify your finances by reducing the number of creditors and payments you must keep track of each month. This can help you better manage your debt, stay organized and allow for greater ease in financial planning.
Debt consolidation can help improve your credit score. Paying off multiple debts with one loan tends to lower overall credit card utilization, reduce negative marks on credit reports and keep accounts current. You can expect a new debt consolidation loan to temporarily lower your credit score since you’re opening a new credit account. Still, these factors can help you establish a better credit history and improve your credit score overall.
Debt consolidation does have a few drawbacks. Though the best debt consolidation loans depend on situational specifics, even loans with favorable terms can increase the time it takes to pay off existing debt.
Additionally, qualifying for a debt consolidation loan can be challenging if you have a poor credit rating or credit history. Similarly, those with a large debt will generally find consolidation loans unaffordable.
Finally, if you don’t make the monthly payment on your debt consolidation loan, you could end up with even more debt than you started with.
Debt consolidation loans examples
Banks, lenders or debt consolidation companies offer several different kinds of debt consolidation. Regardless of their form, debt consolidation loans can pay off credit card debt, medical bills, student loans and other types of debt, including any fees owed to a debt settlement company or debt consolidation lawyer.
Personal loans
Personal loans are the most common type of debt consolidation loans. When you get a personal loan, you borrow a single lump sum from one bank or credit union and then use it to pay off your debts.
The goal is to borrow at a lower interest rate, and this rate will vary depending on your credit and the loan amount. Personal loans come with fixed repayment terms and they can be an excellent option for borrowers who want to avoid bankruptcy while simplifying their debt repayment plan.
Balance transfer cards
You can use balance transfer cards to pay off multiple sources of debt. With a balance transfer card, you transfer the balances of your existing debts into a single account with a lower interest rate, which can sometimes be as low as 0% for an introductory period.
This can be a great option if you want to reduce the overall interest rate you owe and make your debt more manageable. However, balance transfer cards typically come with transfer fees, so comparing the terms carefully before deciding is essential.
Home equity loans and lines of credit
Home equity loans are another way to secure a lower-interest debt consolidation loan. With this kind of loan, you borrow against the equity you’ve built up in your home to pay off existing debts. These typically come with lower interest rates than other debt consolidation loans, making them an excellent option for borrowers who want to save on interest.
However, a home equity loan can put your home at risk if you cannot make your payments. Considering the risks carefully before taking out a home equity loan is important. Consult with a credit counselor or debt consolidation lawyer to ensure you understand all the details.
How debt consolidation impacts credit
Debt consolidation can impact your credit positively and negatively, and it’s not always clear which might be the case.
Debt consolidation can help reduce the interest you’re paying on your debt, thus reducing your overall monthly payments. This frees up more money in your budget, potentially allowing you to pay off your debt faster.
A debt consolidation loan can also help improve your credit score by unifying multiple loans into one lower-interest-rate loan. However, if you consolidate your debt but continue to spend beyond your means, you could fall further into debt, harming your credit score. Remember, when you open a new account, there will be short-term negative impacts on your credit because it’s a new account, and creditors make a hard credit inquiry when you apply.
Overall, debt consolidation can be a great tool to help you manage debt. Still, weighing the potential pros and cons before deciding on consolidation vs. bankruptcy is crucial. Consider options such as personal budgeting and debt management plans or if you should negotiate with debt collectors before deciding if debt consolidation is right for you.
What is bankruptcy?
Pros
- Bankruptcy offers immediate relief from creditors, as they are prohibited by law from seeking payment from you or your business once bankruptcy proceedings have been filed
- It allows you or your business to have a fresh financial start
- Bankruptcy allows for some or all of your outstanding debt to be canceled
Cons
- Bankruptcy has a significant negative impact on your credit score, which can make it challenging for you to get credit in the future
- Bankruptcy is a matter of public record and will be visible to potential employers or landlords, which can make it difficult to obtain employment or housing
- Typically, bankruptcy is a long and complex process that can be quite costly
- Filing bankruptcy won’t discharge all kinds of debts. Some types of debt, such as certain taxes, alimony, child support and student loans, are not eligible for discharge
Bankruptcy is the legal process by which debtors are relieved of their financial obligations. It allows an individual or business to be declared insolvent, provided they meet specific requirements and make all reasonable efforts to pay off existing debts.
After bankruptcy filings, a court will discharge all of your outstanding debt, meaning you will no longer be liable for its repayment.
Bankruptcy can be a powerful tool if you are struggling with overwhelming debt. Still, it should generally only be used as a last resort. Though it provides immediate relief from creditors and a fresh financial start for individuals or businesses, it negatively impacts your credit score.
It’s also not a quick process, as it can take months. And unlike debt consolidation, bankruptcy requires the services of a bankruptcy attorney, which means attorney fees. You must also meet specific criteria, such as passing a means test and not having filed for bankruptcy recently.
Types of bankruptcy
Bankruptcy isn’t a “one size fits all” legal process. Chapter 7 and Chapter 13 are the most common types for individuals, and Chapter 11 is available to businesses. Determining which type might be best for your specific circumstances may require the help of a bankruptcy attorney, but here’s a look at the critical differences between them.
Chapter 7
The most common form of bankruptcy filing, Chapter 7 is also called liquidation bankruptcy, as it requires selling or liquidating certain unprotected assets to pay off unsecured debt.
This type is available to individuals, partnerships and corporations. It allows you to discharge debts, but only after all assets not legally protected are sold to help pay off creditors. Protected assets, such as clothing, household items and more, are exempt from liquidation. Exempt assets vary by state.
Chapter 11
Chapter 11 bankruptcy is available to financially distressed businesses, allowing them to reorganize their finances and renegotiate debts with creditors. This is a less common debt relief route than other types of bankruptcy. It enables the debtor to continue business operations while reorganizing and paying debts.
Chapter 13
Chapter 13 bankruptcy is similar to Chapter 11 reorganization bankruptcy, but it’s only available to individuals. Sometimes also called a “wage earner’s plan,” this type of bankruptcy allows you to create a plan to pay off debts over three to five years. It’s a good option if you can make some payments but are struggling with others or cannot pay off all of your debt in a lump sum.
How bankruptcy impacts credit
When you ask a bankruptcy lawyer to file bankruptcy on your behalf, they ask the court to discharge or erase some or all of your debts. Those to whom you owe money can no longer seek repayment and must write off any losses. Understandably, this process can significantly impact your credit score, affecting your ability to obtain credit in the future.
Filing for bankruptcy will appear on your credit report for up to 10 years. Removing a bankruptcy from your credit report is usually difficult or impossible. This will decrease your credit score significantly, making it more difficult to secure future credit.
Filing for bankruptcy can make qualifying for mortgages or car loans challenging. If approved for these lines of credit, you can expect to pay a higher interest rate than someone without bankruptcy on their credit report.
It can also limit the type of credit that you’ll be eligible for in the future. For example, someone with bankruptcy on their credit report may be limited to secured credit cards, which require security deposits and often have higher interest rates.
Overall, filing for bankruptcy can significantly affect someone’s credit score and ability to obtain credit in the future. It is vital for anyone considering filing for bankruptcy to understand the potential consequences and to consider their other options first.
Find the best solution to your financial situation
Is it better to file bankruptcy, or are debt consolidation programs better? Ultimately, your particular needs will dictate the best solution to your financial problems.
When it comes to debt relief vs. bankruptcy, each has its benefits and drawbacks. Each can be right for various cases, and carefully weighing your options is crucial. It’s always a good idea to consult with a financial advisor or bankruptcy lawyer to help analyze your current financial situation.
Debt consolidation for bad credit may be a better solution for someone struggling but still able to make regular payments. Bankruptcy debt relief is generally better if your debt has become unmanageable or is too large for you to repay.
Whatever you decide, it’s better to address an unmanageable or overwhelming financial burden and take steps to free yourself from debt and worry. Whether you file for bankruptcy or pay off debt, being able to move toward a secure financial future is a goal worthy of pursuit.