Debt Consolidation vs Bankruptcy – Which Is Best for You?
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If you're feeling overwhelmed by a large amount of debt, bankruptcy and a debt consolidation loan are two of the most common debt relief options. And while these debt management plans are the go-to for most people, it doesn't necessarily mean they'll be suitable for you. Your current debts, budget, and income all come into play in determining your right course of action. So while it may work for most people, it may not be an option for you because each situation is different.
But it’s crucial to understand the difference between debt consolidation and bankruptcy to make an informed decision.
In this article
What is debt consolidation?
Debt consolidation involves combining two or more loans into a single loan with a lower interest rate and a lower monthly payment. If you qualify for debt consolidation, you may be able to consolidate credit card debt, student loans, medical debt, or any other kind of debt you have. In some cases, you may not even have to make a payment on your credit card for a few months while you work on the debt consolidation loan. Debt consolidation companies charge a fee for their services.
Related: Debt Consolidation for Bad Credit
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Benefits of debt consolidation
- Pays debt faster: For some people, debt consolidation can make it possible to pay off their debt faster. It can also simplify your finances and make your financial situation more manageable.
- Reduces interest rate: Consolidating your debt can reduce interest payments by thousands of dollars each year, depending on your total debt load. This can make it easier to stick to a budget and make regular payments.
- It's easier to manage: It's one monthly payment versus multiple. Go figure! The combined monthly payments are much easier to manage than separate payments on multiple credit cards or loans.
- Improves credit score: Your credit score determines the interest rate you qualify for when you get a new loan or a line of credit. And debt consolidation can improve your credit score and help you get out of debt more quickly.
How does debt consolidation work?
To qualify for a debt consolidation loan, you will need a steady source of income. You will want to check the interest rates and fees for any available loans to find one that offers the lowest cost and the best terms for your situation. You will also need proof of income and any other information your lender requires. In most cases, you will need to provide your Social Security number and other details to ensure everything is processed correctly.
In addition, you may need to go through a few additional steps based on your specific situation, so it is a good idea to read over all of the lender's terms and conditions before applying. Once the application is complete, the lender will issue you a debt consolidation loan backed by the equity in your home (formally called a home equity loan) or another asset you own. You can use the funds to pay off your existing debts and make a single monthly payment to the lender instead of multiple payments to individual creditors.
Why you might choose debt consolidation?
For most people, the biggest benefit of debt consolidation is that it takes the stress out of paying several different bills each month. Instead of managing several loans and credit card debts, you will have just one payment to make each month. This can make it much easier to keep track of your expenses and stay within your budget. For some people, this can also help them avoid missing a payment and negatively affecting their credit score. It is also possible to get lower interest rates with debt consolidation loans than with other loan products to save money in the long run.
In addition, if your loan is backed by an asset you own, you can access the funds if you experience an unexpected financial emergency. This means you won't have to turn to high-interest credit cards or take out another personal loan to make ends meet. For many borrowers, debt consolidation can also make paying off their debts more manageable. They can make one larger payment each month instead of keeping track of payments for several different types of debt. This can make establishing a repayment plan easier to ensure you pay off your debt as quickly as possible. If you have trouble keeping up with your monthly bills, consolidating your debts could be a great option.
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- Apply in 5 minutes. If you qualify, chat online with a friendly online debt representative.
What is a bankruptcy?
Bankruptcy is a legal process through which a person or business can resolve outstanding debts and obtain a fresh start. Bankruptcy laws protect consumers from losing their assets to repay debts. A person or business may file either Chapter 7 or Chapter 13 bankruptcy, depending on the nature of the debt and the resources available to repay it.
- Chapter 7 bankruptcy: This type of bankruptcy involves liquidating assets to pay off outstanding debts. Unsecured debts like personal loans and medical bills may be discharged in exchange for a lump sum payment or sold for cash to cover a portion of the debt. However, secured debts, alimony, and child support aren't discharged. You'll have to go through a means test, which aims to determine you're eligibility.
- Chapter 13 bankruptcy: This bankruptcy filing involves a payment plan that allows the debtor to repay the debt in manageable installments over three to five years. The debtor must also continue paying any secured debts, such as a mortgage, during the repayment period.
Related: Is Chapter 13 an Option After Chapter 7?
How does bankruptcy work?
Most people who file for bankruptcy do so under Chapter 7 of the US Bankruptcy Code. Under this chapter, a debtor whose unsecured debts total less than $394,725 and secured debts total less than $1,184,200 may be eligible to discharge certain debts in return for giving up nonexempt property. To qualify for Chapter 7, the debtor must not have filed for personal bankruptcy in the past eight years or be behind on child support payments or other court-ordered obligations. To qualify for Chapter 13 bankruptcy, the debtor must have regular income that can be used to make payments on the debt and must not currently be engaged in a Chapter 7 case or a case under another chapter of the Bankruptcy Code.
Once the debtor files a bankruptcy petition with the bankruptcy court, an automatic stay goes into effect that prevents creditors from taking action against the debtor while the case is proceeding. In some cases, the stay allows the debtor to continue operating a business for the duration of the case. In other cases, the stay requires the debtor to cease all business operations, including selling inventory or assets.
Benefits of bankruptcy
- Discharges debs: Although you cannot discharge all your debts through a Chapter 7 bankruptcy, you can discharge most debts. This means you no longer have to pay your debts once the bankruptcy is complete. This is especially helpful if you have a high-interest loan that you owe to your credit card company or a loan with a balloon payment due in the near future. By discharging your debt, you can save yourself a significant amount of money in the long run.
- Eliminates debt collectors: Another benefit of filing for bankruptcy is that it can stop collection efforts by creditors and debt collectors. This means that you will no longer have to deal with harassing phone calls from debt collectors while filing for bankruptcy. As a result, you don't have to worry about wage garnishments, threats of jail time, or property foreclosure ... at least temporarily.
- Protects your assets: If you file for bankruptcy, you may be able to protect some of your assets from your creditors. However, this protection is based on your equity in the asset.
- Repairs your credit rating: Bankruptcy can also help you to repair your credit score. During the bankruptcy process, your credit rating may temporarily drop due to your missed payments on your credit cards and other loans. However, once your case is completed, you should be able to improve your credit score as you start making better financial decisions. A good credit score can help you get lower rates on future loans and credit cards. For the record, bankruptcies remain on credit reports for 10 years. A balance transfer credit card would be the right step toward rebuilding your credit post-bankruptcy.
Related: How to Recover from Bankruptcy
Is bankruptcy right for you?
Before filing for bankruptcy, you should take some time to consider whether this option is truly your best option for dealing with your debt problems. Filing for bankruptcy has several benefits and drawbacks that you should take into consideration before you make a final decision. While bankruptcies can help some people to get a fresh start, they may not provide the solution you are looking for. Seeking a financial professional's advice before deciding to file a bankruptcy can provide you with some valuable insight and help you determine the best solution for dealing with your debts.
In some situations, filing for bankruptcy may be a good option for you to consider. For example, if you are in a great deal of debt because of an unexpected medical emergency or job loss, it may be your best option for getting back on track financially. If you have very little income and cannot keep up with your monthly bills, bankruptcy may help you get the relief you need to regain control of your finances. You may also want to consider filing for bankruptcy if you’ve tried other debt repayment plans without success and you feel that you have run out of other options for dealing with your debt problem.
Related: Handling Debt After A Divorce
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- Relieve $25k+ in credit card debt or personal loan debt with this special relief program.
- TurboDebt has a Trustpilot rating of 5/5 based on 1288 reviews
- Subject to qualification and approval. $1,500 monthly income required.
- Apply in 5 minutes. If you qualify, chat online with a friendly online debt representative.
The bottom line
Bankruptcy is an option that some people choose to deal with their debts. This is intended as an opportunity for people facing serious financial problems to get a fresh start and move on with their lives. When done properly, it can allow a person to rebuild their credit and start fresh financially. Debt consolidation, on the other hand, is a means of getting one's finances under control by eliminating high-interest loans and making more manageable payments toward paying off the remaining debts. Both options have advantages and disadvantages that should be considered before choosing the one that is right for you.
However, before deciding whether or not to pursue these debt relief strategies, you may want to get advice from a financial professional who can help you to determine which option is the best solution for your situation. Alternatively, you could talk to a nonprofit credit counseling agency or consider the services of debt settlement companies, which negotiate with your creditors so you can make one lump sum payment for less than you owe and become debt free.
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Writer
Jasir Jawaid is Joy Wallet's Assistant Editor. He has more than 13 years of experience as a journalist covering Wall Street, equities, financial policy and regulation, and cryptocurrency and blockchain.
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