Is Debt Consolidation a Good Alternative to Bankruptcy?[yoast-breadcrumb]
Is Debt Consolidation a Good Alternative to Bankruptcy?
If you’re struggling with debt, you may be wondering if debt consolidation is a better option than declaring bankruptcy. Both can provide relief, but they work very differently. This article will explain the pros and cons of each, so you can decide which path is best for your situation.
What is Debt Consolidation?
Debt consolidation involves taking out a new loan to pay off multiple debts. This new loan ideally has a lower interest rate and monthly payment than what you currently owe. You end up with just one payment instead of many.
There are a few main ways to consolidate debt:
- Balance transfer credit cards – Transfer balances from high-interest cards to a new card with a 0% intro APR for a set period of time.
- Debt consolidation loans – Banks, credit unions, and online lenders offer personal loans specifically for consolidating debt.
- Home equity loans or lines of credit – Use your home equity to pay off credit card and other unsecured debts.
The goal is to reduce your interest rates so more of your payment goes toward principal rather than interest. This can help you pay off debt faster. Your credit may also improve if you make on-time payments on the new loan.
What is Bankruptcy?
Declaring bankruptcy involves filing a petition in federal court to eliminate or reduce debts you can’t afford to pay. The court appoints a trustee to oversee liquidating your assets and distributing payments to creditors. After the process is complete, eligible debts are discharged – meaning you are no longer legally obligated to pay them.
The two most common types of consumer bankruptcy filings are:
- Chapter 7 bankruptcy – Liquidates assets to pay creditors. Any eligible debts remaining after assets are distributed are discharged.
- Chapter 13 bankruptcy – Allows you to keep assets while repaying a portion of debt over 3-5 years. After repayment, eligible debts are discharged.
Bankruptcy stays on your credit report for 7-10 years and can make it difficult to get approved for future loans and credit cards. However, it provides immediate debt relief through discharging debts you can’t afford.
Key Factors to Consider
When determining whether bankruptcy or debt consolidation is better for your situation, here are some key factors to consider:
- Your credit score – The higher your score, the lower interest rate you can qualify for with consolidation. Under 620 will make approval difficult.
- Your income – Steady income makes it easier to qualify for a consolidation loan and repay it.
- Type of debts you have – Medical bills or other unplanned expenses may be better addressed through bankruptcy.
- Your state’s bankruptcy exemptions – These determine assets you can keep, like home equity.
You’ll also want to think about how soon you need relief. Bankruptcy provides immediate debt discharge, while consolidation takes time to pay off debts.
Pros of Debt Consolidation
If you’re able to qualify for a consolidation loan, here are some potential benefits:
- Lower interest rate saves money over time
- Consolidates multiple payments into one
- May improve credit score with on-time payments
- Allows you to keep all assets
- Less impact on future loan/credit approval than bankruptcy
Being able to make just one monthly payment can make managing bills easier. And reducing interest rates through consolidation can save thousands of dollars compared to high-interest debts like credit cards.
Cons of Debt Consolidation
There are also some potential downsides to weigh:
- Loan approval with bad credit can be difficult
- Closing costs and fees can add to overall repayment cost
- Debt is not eliminated, only restructured
- Missed payments can put all collateral at risk
- Repayment timeline may be quite long depending on amount owed
Even with a lower monthly payment, paying off the full balance of a consolidation loan can take years. Missed payments put any collateral securing the loan at risk of repossession. And if you don’t qualify for an affordable rate, consolidation may not provide much benefit.
Pros of Bankruptcy
Filing for bankruptcy provides several advantages not offered by consolidation:
- Immediate debt relief through discharging eligible debts
- Chance to keep certain assets protected by exemptions
- Stops collections calls and lawsuits from creditors
- Allows rebuilding credit a few years after filing
- Chapter 13 bankruptcy stops foreclosure and repossession
Bankruptcy provides fast relief for those truly unable to keep up with minimum payments, even at lower interest rates. Eliminating debt payments can allow you to afford necessities or get back on your feet financially.
Cons of Bankruptcy
There are also downsides to bankruptcy to consider:
- Bankruptcy stays on credit reports for 7-10 years
- Future loan/credit approvals will be difficult
- Some property may be liquidated to repay creditors
- Chance creditors contest discharge of certain debts
- Costly attorney fees, filing fees, and trustee payments
The impact on your credit score and report makes getting approved for financing difficult after bankruptcy. And creditors may fight to prevent certain debts, like student loans, from being discharged.
Alternatives to Bankruptcy
If bankruptcy and consolidation don’t seem right for your situation, here are a few other debt relief options to consider:
- Credit counseling – Get help managing debt through a non-profit credit counseling agency.
- Debt settlement – Negotiating directly with creditors for reduced payoff amount.
- Sell assets – Downsize house, car, valuables to pay down debts.
- Pick up side work – Extra income from a side job can help tackle debts.
Credit counseling provides budgeting and money management advice. Debt settlement lets you negotiate payoff discounts directly with creditors. Taking on additional work or selling unneeded assets are other ways to come up with extra money to put toward debt.
- Debt consolidation restructures debt into a new loan with lower interest.
- Bankruptcy eliminates or reduces debt through a court process.
- Consolidation works best for those with good credit and steady income.
- Bankruptcy provides immediate relief but hurts credit long-term.
- Consider all options to find the best debt relief strategy for your situation.
There is no one-size-fits-all solution for getting out of debt. Consider both the pros and cons of consolidation versus bankruptcy. Factor in your specific circumstances to determine which option may provide the best path forward.