Debt Consolidation vs Bankruptcy - Which is Better

Debt Consolidation vs. Bankruptcy

Bankruptcy should be considered vs. Debt Consolidation unless you do not qualify.  The common disqualification reasons are:

  1. You make too much money;
  2. You already filed Bankruptcy and received a discharge within the last 8 years.
  3. You have non-exempt assets. 

Chapter 7 Bankruptcy can discharge all of your unsecured debts while you keep paying for your car and house.

What is Debt Consolidation?

Debt consolidation, in its truest form, is taking several debts and combining them into fewer debts. For instance, if you have more than one student loan, it’s usually an option to consolidate them into a single loan. If you own a home, you might be able to take out a home equity loan and use the proceeds to pay off credit card debt, essentially combining all of the credit card debt into the new loan using your home as collateral. These are debt consolidation loans and not actually consolidation programs or debt management programs.

As far as the type of debt consolidation we’re comparing to bankruptcy here a third-party, usually a company calling itself a debt management program or consolidation service “helps” you consolidate your debt.

The debt consolidator promises to work with your lenders to improve your debt situation, and advises you to stop making payments directly to these companies and instead, pay a single payment to the consolidation company each month. They claim to help you manage debt or settle debt for you, when in fact they are preying on your desperate situation and doing little for you aside from making the situation worse.

Debt consolidation companies claim they are using the money you’re giving them each month to pay down your debt. They might try to negotiate the interest rates with your creditors or offer to negotiate a settlement on your behalf. In exchange for their services, they are keeping a portion of what you’re giving them each month as payment.

Under the best circumstances, debt consolidation companies are charging you for a service you don’t really need. Some people don’t have a problem paying because they are intimidated by the idea of contacting their creditors and negotiating better rates or a better payment arrangement. But the truth is you can do these things for yourself and it costs you nothing. It’s possible to contact your credit card companies, explain your situation, and ask if they can work with you to make payments more affordable. It’s in their interest to do this because they know they stand to lose out on all of the money you owe them if you’re forced to take drastic measures.

So even under the best of circumstances, debt consolidation companies are charging you for a service you don’t really need

But it gets much worse.

Some debt consolidation companies don’t ever contact your creditors. They advise you to stop making payments, pushing your accounts into default. This puts you at risk for facing legal action from your creditors – something a debt consolidation can do nothing to help you with. The company keeps the money, or a large portion of the money, you’ve paid them, and you get no benefit whatsoever. Money you could’ve paid toward your debt or used to file for bankruptcy is gone and you’re situation is at least no better off than when you started.

Risks of Debt Consolidation

Consolidating your debt might seem like a better option than bankruptcy, but it rarely is when you’re working with a debt consolidation program.

Some of the risks include:

  • Spending a lot on fees, and in many cases, hidden until it’s too late
  • No guarantee creditors will work with the debt consolidator – some lenders refuse to negotiate with third-party firms
  • Damages your credit
  • Does you no good unless you complete the entire program – assuming the program is worth completing to begin with

Is Bankruptcy a Better Option?

Despite bankruptcy seeming like the most drastic option for dealing with debt, it can actually be far more beneficial than working with a third-party debt consolidation program.

Of the various types of bankruptcy, Chapter 7 and Chapter 13 are the two most common used by individual consumers. In Chapter 7 bankruptcy, your unsecured debt is discharged and you are no longer legally obligated to pay what you owe. In Chapter 13, your debt is restructured and you enter into a multi-year payment plan that is overseen by the bankruptcy court and your bankruptcy trustee.

One of the first things you do when you meet with a bankruptcy lawyer is discuss your situation and take the bankruptcy means test which helps you determine whether or not you qualify for Chapter 7 bankruptcy.

Bankruptcy is by no means perfect.  However, if your financial struggles are severe enough that you’re considering debt consolidation programs or bankruptcy, chances are your credit has already suffered and you don’t stand much of a chance of getting a decent loan anyway.

Despite the downside, bankruptcy offers a number of advantages. It allows you to take charge of the situation and stop the endless calls from creditors and bill collectors. It is cut and dry, meaning you don’t need to worry about hidden fees or creditors rejecting settlement offers as you do when you work with a debt management or debt consolidation program. Perhaps best of all, it gives you a place to begin to improve your financial situation. It’s a fresh start that allows you to redo many of the financial missteps you’ve experienced.

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