Many people accumulate at least some debt as they go through life. Unfortunately, if you have trouble paying off debt, high interest rates can make it snowball fairly quickly. When this happens, you might start comparing the benefits of debt consolidation vs. bankruptcy.
While both options can help you get out of debt, each one isn’t necessarily right for every situation. Here’s how to decide on the best way to eliminate debt.
Debt Relief Options Compared: Debt Consolidation vs. Bankruptcy
Before asking, “Should I file for bankruptcy or consolidate debt,” it’s important to learn the basics of each approach.
Debt Consolidation
When you consolidate your debt, you effectively refinance it. This is usually done via a debt consolidation loan. Here’s how it works:
- You add up your existing debts
- You apply and qualify for a consolidation loan
- You use the loan funds to pay each debt
- You make monthly payments toward the loan
Debt consolidation can help you combine several monthly payments into one. Ideally, your consolidation loan will also have a lower interest rate than your existing debt, so you’ll pay less over time.
Bankruptcy
Bankruptcy is a complex legal process that allows the filer to get out from under overwhelming debt. If you elect to pursue bankruptcy, you’ll likely choose from one of these options:
- Chapter 7: Wipes out most kinds of unsecured debt
- Chapter 13: Restructures debt to make it easier to pay off
Chapter 7 bankruptcy is usually the best course if you have few assets and little income. Although it erases many kinds of debt, certain assets may be seized and sold to pay your creditors.
Chapter 13 bankruptcy doesn’t eliminate debt, but it allows you to keep your assets. It may be a better option if you have a steady income and assets you don’t want to lose.
Before you seriously consider this option, you should have a clear understanding of what cannot be wiped out by bankruptcies.
Chapter 7 bankruptcy voids most kinds of unsecured debt (debt that doesn’t have a house, car, or other asset as collateral). However, it usually doesn’t clear the following debts:
- Student loans
- Tax debt
- Past-due child and spousal support
- Court-ordered restitution and fines
The impact of bankruptcy on credit scores can be significant. However, with time and good credit habits, your score can bounce back. According to Experian, Chapter 7 bankruptcy stays on your credit report for 10 years, while Chapter 13 bankruptcy stays on your report for seven years.
When to Choose Debt Consolidation
You might be wondering, “At what point should I consider debt consolidation?” You may be a good candidate for consolidation if the following conditions apply:
- You have good credit and enough income to repay the loan
- You think you can realistically pay off your debt
- You’re confident you won’t generate more debt while paying off your loan
Before seeking out a consolidation loan, make sure you know how to consolidate debt effectively. Consolidation only makes sense if your loan has a lower interest rate than your existing debt. If the interest rate is higher, you’ll likely end up paying more over time.
When to Consider Bankruptcy
What is the minimum debt level for bankruptcy? There’s no specific threshold to declare bankruptcy, but you might consider this path if you check the following boxes:
- You don’t think you can realistically repay your debt
- You already have poor credit
- You’ve explored other options, but nothing has worked
Are There Other Options?
Debt consolidation and bankruptcy both have their advantages and disadvantages. However, they aren’t your only choices if you’re determined to get out of debt.
One option that’s worked for millions of people is debt settlement. This is when you negotiate your debts down and resolve them by paying less than what you owe. While settling your debt can cause your credit score to dip temporarily, the impact is often less severe than that of bankruptcy.
You can contact your creditors and attempt to negotiate your debt on your own, but you may have better luck by working with a debt relief agency. At National Debt Relief, we keep the process as streamlined as possible:
- You’ll put money in a dedicated savings account instead of paying creditors
- We’ll contact your creditors and attempt to negotiate your debt
- With your permission, we’ll use the funds in the savings account to pay the negotiated lower amount
Is it better to settle debt or file bankruptcy? It depends on your circumstances, but many financial professionals suggest only filing for bankruptcy as a last resort.
Choosing the Right Debt Solution
It’s easy to get stuck in a loop of endless minimum payments. While you might eventually pay off all of your debt this way, you’ll likely end up paying hundreds (or even thousands) more than you need to. If you’re having trouble paying your debt, you owe it to yourself to ponder all of your options.
Deciding on debt consolidation vs. bankruptcy can be difficult, but you don’t have to make this important decision alone. An experienced financial professional can offer personalized guidance and help you start working toward your financial goals.
