When you are struggling and have overextended yourself, the first step toward getting out of debt is taking action. But, what course of action is best? Should you consider debt consolidation or file bankruptcy? Understanding the differences between these options can help you determine which is best for your financial situation.
What is debt consolidation?
Debt consolidation is merging all of your individual debts into a single debt with one monthly payment. Instead of having to keep track of multiple due dates and payments, you make one single monthly payment to a single lender, like a debt consolidation company.
Debt consolidation companies offer you either a secured or unsecured loan and, in turn, pay your creditors. However, if you have decent credit, you may qualify for a debt consolidation personal loan through your bank or credit union.
What is a debt consolidation company?
A debt consolidation company is a business that offers assistance with debt consolidation and debt settlement services. They either provide you with a loan to pay off your consolidated debt or will attempt to lower your debt by negotiating a settlement with your credit card companies and other lenders.
For using their service, you typically pay a service fee and are required to make monthly payments directly to them until the loan is paid in full. Service fees are often based on the total amount of debt being consolidated or settled. In some cases, this could be as much as 25 percent.
So, if you have $10,000 in consolidated or settled debt, you could pay as much as $2,500 in service fees.
Before agreeing to debt consolidation or debt settlement, get a second opinion with a bankruptcy attorney free consultation appointment. Book your consultation today.
What are the advantages of debt consolidation?
Before you choose to consolidate your debts, it is important to understand the pros and cons, along with the risks of debt consolidation.
- You only have to keep track of one monthly payment.
- You may be able to keep access to your credit cards and other lines of credit.
- It might be possible to slightly reduce your total monthly payments.
- You could get a lower interest rate. So you might save hundreds or thousands of dollars in interest.
- Your credit score could increase because it will reflect all your credit cards and other lines of credit that were paid off.
What are the disadvantages of debt consolidation?
- You might lose your property if your home or vehicle was used as collateral for a debt consolidation loan. If there is a cross-collateralization clause, the debt consolidation company may even be able to take other property and assets if you fall behind on your payments.
- You could find yourself in an even worse financial situation if you continue to use your credit cards and lines of credit after they are consolidated.
- Your total cost of debt could be higher than if you didn’t consolidate. You have to look at the total cost of lending to determine if the interest rate and length of payment will ultimately save you any money in the long run.
- There are upfront costs that are added to your loan. When you consolidate debt, you could be charged loan origination fees, balance transfer fees, closing costs, and other fees. You will want to consider if these fees offset any potential savings you may gain by consolidating your debt.
What is debt settlement?
Debt settlement is a type of debt consolidation offered by debt consolidation companies. They negotiate with your creditors to settle the debt for less than you owe. Taking a debt settlement may or may not be beneficial for you.
For example, many debt consolidation companies will instruct you to stop making monthly payments on your credit card balances and lines of credit. Instead, they will have you deposit the money you would have paid into a savings account.
Then, after about six months, when there is enough money in the savings account, they will start negotiating a settlement with your creditor. They will use the money in the savings account to pay your creditors off. If there is not enough in the account, they will lend you the rest.
What are the advantages of debt settlement?
The only real benefit you gain from debt settlement is if the debt consolidation company can get your debts settled for a significantly lower amount.
What are the disadvantages of debt settlement?
- Your creditors may refuse to settle. If even one of your creditors refuses to participate in a settlement plan, you will still have to pay them.
- The creditors that participate may not be willing to reduce the debt by much. Most original creditors are not willing to go below 80 percent of the total amount owed because they want to recoup as much of the debt as possible.
- You will incur late fees and additional interest on your balances since you are not making payments on your debts.
- Your credit score will take a serious hit because you will have stopped making payments to your creditors.
- You could face risks of collection actions being taken, including lawsuits for wage garnishments or foreclosures.
- You could be assessed a tax liability because the amount of debt forgiven can be reported to the IRS by the creditor as income you earned.
- You will have to deal with collection calls, late notices, and your credit cards and lines of credit will be closed.
What is bankruptcy?
Bankruptcy is a legal proceeding that allows people who are struggling financially to get a fresh start by either eliminating most of their debts or restructuring certain debts into an affordable monthly debt management plan.
In addition, unlike debt consolidation or debt settlement, bankruptcy offers federal protections. There are several types of bankruptcy. However, most individuals and small businesses usually file Chapter 7 or Chapter 13 bankruptcy.
What is Chapter 7 bankruptcy?
Chapter 7 bankruptcy is a proceeding that allows you to eliminate all your unsecured debts, like medical bills and credit cards. Certain assets are exempt, like a personal vehicle up to a specific value and your primary residence. However, if you have nonexempt assets, like a boat, vacation home, or stocks, you usually have to sell these in exchange for wiping away all your unsecured debt.
What is Chapter 13 bankruptcy?
Chapter 13 bankruptcy is another legal proceeding that allows you to restructure your debt into an affordable repayment plan. You continue to make monthly payments, usually to a court-appointed trustee, who pays your creditors their share. At the end of three or five years, any remaining balances are wiped away, giving you a fresh start.
Unlike Chapter 7, when you file for Chapter 13, you are allowed to keep exempt and nonexempt assets since you are repaying your debts.
What are the advantages of filing for bankruptcy?
- Bankruptcy protects you from creditors. The moment you file, the bankruptcy court issues an automatic stay, which prohibits creditors and collectors from contacting you and collecting the money you owe.
- Bankruptcy can stop repossessions and foreclosures. The stay issued by the court automatically stops any legal actions against you for repossessions and foreclosures. It can also stop wage garnishments.
- You may have the option to retain secured assets, like your car and house, by negotiating the terms of your loan with the lender and signing a reaffirmation agreement. You can also decide to surrender those assets when you cannot afford them.
- You may not have to repay any of your outstanding unsecured debt if you meet the requirements for Chapter 7.
- You will pay less money to your creditors than you would with a debt consolidation company when you file for chapter 13.
- The only cost to you is paying your bankruptcy attorney’s legal fees, which are usually a flat rate amount.
- Your credit will recover faster than it would with a debt settlement.
- You get a fresh start once your bankruptcy is discharged.
What are the disadvantages of filing for bankruptcy?
- Bankruptcy will temporarily lower your credit score. However, most people can start to rebuild their credit and boost their credit score within 12 months of their bankruptcy and debt discharge.
- The bankruptcy stays on your credit report for seven to ten years, depending on whether you filed Chapter 7 or Chapter 13.
- Bankruptcy filings are public records. As such, others may find out you filed for bankruptcy, which could be embarrassing for some people.
- There is a mandatory waiting period before you can file for bankruptcy again. So, if you get back into financial problems, you might not be eligible for bankruptcy.
- Not all types of debts can be discharged through bankruptcy. Federal student loans, tax liens, past-due federal taxes, alimony, and child support are some examples of non-dischargeable debts.
How long does it take to recover from bankruptcy?
Recovering from bankruptcy is much faster compared to debt consolidation or debt settlement. However, with debt consolidation, you will have to continue to make monthly payments until your consolidation loan is paid in full.
With debt settlement companies, you must also continue making monthly payments until your settlement is paid off. Not to mention, your credit will have been adversely affected, and any negative reporting will remain on your credit report for seven to eight years.
On the other hand, by filing for bankruptcy, once it is discharged, you will notice your credit can start to recover in as little as 12 months or faster when you know how to recover from bankruptcy. So even though the bankruptcy will remain on your credit report for quite some time, as you rebuild your credit, it will become less and less of a factor.
How can I decide if filing for bankruptcy is right for me?
Since every financial situation is unique, it needs to be carefully evaluated. The best place to start is by scheduling a free consultation with a Las Vegas attorney for bankruptcy. There is no cost or obligation to determine if filing bankruptcy could be the best option for you and give you the fresh start you deserve.
Are you considering bankruptcy? Get a free consultation with a bankruptcy attorney to discuss your options to see if bankruptcy is right for you.
Investopedia. When to Declare Bankruptcy.
NerdWallet. Are Debt Consolidation Companies Worth It?