Debt Consolidation or Bankruptcy: Which is Right for You?

Considering debt consolidation versus bankruptcy can feel like choosing between a bad apple and a bad banana. Either one will make your stomach turn.

But making the right choice between these two options could make you feel much better about your financial situation. Here’s what you need to know about the basics of debt consolidation and bankruptcy.

Debt consolidation vs bankruptcy: the basics
Main advantages and disadvantages of debt consolidation
Main advantages and disadvantages of filing for bankruptcy
Debt Consolidation vs Bankruptcy: Which is Best for You?

Debt consolidation vs bankruptcy: the basics

Debt consolidation involves taking on new debt to cover your old debt.

You could take out an unsecured personal loan, for example, to pay off what you owe to creditors. A A home equity line of credit or a balance transfer credit card are other strategies for the same end goal.

It may seem counterintuitive to take on different debts when you already feel like you’re drowning. But getting the right personal loan could get you a lower interest rate and make your repayment easier.

Bankruptcy has its own set of rewards and consequences. You can pay off some or all of your debt through Chapter 7 bankruptcy, or pay off some or all of your debt with a new repayment plan through Chapter 13 bankruptcy.

With either procedure, however, you will hurt your credit report for years to come.

Main advantages and disadvantages of debt consolidation

Debt relief companies or debt consolidation programs offer debt consolidation as a service, but at a cost. However, you could consolidate your debts on your own, without opening your wallet.

Instead of paying for professional advice, rely on a certified credit counselor working for a non-profit organization. You can find a list of legitimate credit counseling agencies via the justice department.

Before pursuing debt consolidation, check out the following pros and cons.

Pros: Make one payment to one lender

If you’ve fallen behind with multiple creditors, you might like the idea of ​​making one payment to one lender.

For example, you could take out a personal loan, use the funds to pay off all your creditors, and then focus 100% of your energy on paying off the new loan.

Disadvantage: You must have strong credit (or a strong co-signer)

The trap to debt consolidation is that you will need at least strong credit to qualify for a loan, and even better credit to get the lowest interest rates possible.

The reality is that if your finances are in a mess, your credit score could be too.

Still, there are ways to consolidate your debt with bad credit. You could find a co-signer and piggyback on their strong credit report, for example.

Advantage: you could get a lower interest rate

Suppose you have credit card debt with an APR of 15.00%. With a personal loan, you might find an even lower rate if you qualify or have a co-signer who does. these approved personal lenders, for example, offer rates starting well below 10.00%.

That said, be on the lookout for mounting fees from personal loan companies. When shopping, compare APRs, as they include both the interest rate and origination fees, if there is one.

Disadvantage: you can continue a cycle of debt

Although a unsecured personal loan could erase some or all of your existing debt, you will still be responsible for paying off new debt.

To break the debt cycle, it’s wise to stop borrowing money as soon as you’ve consolidated your debt. Start by cutting up your credit cards and reassessing your spending habits.

Pros: You can set an end date for your debt

Credit card debt has no predetermined end line. You can make monthly payments to your card issuers and feel like your repayment stretches over an eternity.

With debt consolidation, you work with your lender to choose a fixed repayment term. Numerous Personal loan companies offer a range of repayment terms of five years or less.

You may also find lenders offering longer repayment terms to lower your monthly payment amount. Know that the longer your term, the more interest you will pay over time.

Main advantages and disadvantages of filing for bankruptcy

You must have a minimum income to prove your inability to repay your debt when you file for Chapter 7 bankruptcy.

You are giving up non-exempt assets to repay secured debt. You may even have to assign other property to pay off unsecured debt.

You can assess your eligibility for Chapters 7 and 13 bankruptcy proceedings by working with a credit counselor to review your options. Consider these pros and cons before you go this route.

Disadvantage: you could lose your property and assets

With a Chapter 7 bankruptcy, any assets that can be turned into cash will be used to pay off your debt. Only exempt assets, which are determined by your state’s laws, would be protected from sale.

If you prefer to keep your assets, such as saving your home from foreclosure, you can opt for a Chapter 13 bankruptcy. But you would want to consult with a credit counselor or bankruptcy attorney to review your options.

Pros: You can press the reset button on your refund

With a Chapter 7 bankruptcy, you could liquidate some or all of your debt.

With a Chapter 13 proceeding, you would establish a three to five year repayment plan for your remaining debt. This repayment plan might even give you the convenience of a single monthly payment if you work with a credit counselor on a debt management plan.

Con: You’ll have to prepare for attorney and court fees

Even if you pay off some or all of your debt through bankruptcy, the process itself can keep you in trouble.

In addition to paying the bill for a bankruptcy attorney, there are a variety of legal costs to manage. You can expect to shell out between $1,500 and $4,000 on average, according to

Pros: You can rebuild your credit (eventually)

Bankruptcy will damage your reputation as a short-term borrower, but you can rebuild your long-term credit.

With your bankruptcy behind you, you could start by monitoring your credit report and taking small steps, like becoming an authorized user on a loved one’s credit card.

Disadvantage: it may not be the fresh start you imagined

Whether you’re considering Chapter 7 or Chapter 13 bankruptcy, it won’t give you the clean slate you might be expecting.

For one thing, you’re unlikely to repay every penny of your debt. Student loans are hard to get discharge through bankruptcy, for example.

Even if you are among the minority of consumers who could emerge from a debt-free procedure, you will find yourself with little or no assets and a credit history in need of serious repair.

Consider that if you attempted to borrow a federal Parent PLUS student loan, for example, the Department of Education would consider you to have an adverse credit history if your bankruptcy occurred within five years. Private lenders would also be skeptical of a credit report showing recent bankruptcy.

Debt Consolidation vs Bankruptcy: Which is Best for You?

Debt consolidation is generally preferable to bankruptcy because it puts you in control. With a The debt consolidation loan, for example, simplifies your repayment. You also start working towards a debt-free date.

But debt consolidation is not for everyone.

“Taking out a loan to consolidate debt can make sense when an individual is optimistic about improving their financial situation,” said debt relief lawyer Simon Goldenberg. “However, if [they’re] in the event of a severe financial crisis, a consolidation loan is likely only a temporary fix, as the borrower may find it difficult to keep up with payments.

Ultimately, Goldenberg said, a borrower might just “get off the road” with debt consolidation if they can’t find a long-term solution to managing debt repayment.

If your debt is beyond the point of being helped by consolidation, you might consider bankruptcy. It’s the closest thing to getting an overhaul in your financial life. The court case could even allow you to discharge part or all of your debt.

Rebuilding your savings and credit will take time after filing for bankruptcy. But student loans lawyer Stanley Tate said some of his clients added 100 points to their credit score within 18 months of bankruptcy.

“Declaring bankruptcy is a purely mathematical question,” Tate said. “Yes [the math makes sense]you can get rid of thousands of dollars in debt faster and more cheaply than consolidating.

Seek advice from a credit counselor or bankruptcy attorney to make the best decision for you. Don’t get sucked into anything that isn’t in your best interest.

If you’re still hesitating between debt consolidation and bankruptcy, consider creating a debt management plan as an alternative strategy.

For a fee, a debt relief company can provide additional support to people burdened with debt. This service often includes negotiating with creditors on your behalf to lower monthly payments, rates, and what you owe. It can also restructure your debts into a single monthly payment plan. Many debt relief companies will also provide advice to help you create a budget that works.

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