Debt Consolidation Vs. Bankruptcy: What Is The Difference? Forbes Advisor – Forbes

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If youre looking for a way out from under overwhelming credit card bills and other debt, bankruptcy could wipe out your balances and offer a fresh start. But filing for bankruptcy has downsides, so you might consider debt consolidation as a way to simplify your finances and pay off debt faster.

Debt consolidation and bankruptcy are two very different things, though both can provide relief when debt seems hopeless. Understanding the differences between debt consolidation and bankruptcy can help you make the right choice if you find yourself buried under bills.

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Debt consolidation is a financial strategy for paying off debt. Though it might be considered a form of debt relief, you wont be forgiven any of your debt; instead, you trade it all in for one new loan, often at a much lower cost.

Debt consolidation might involve getting a personal loan from a bank or credit union, taking out a home equity loan or line of credit (HELOC), or applying for a 0% APR balance transfer credit card to swallow up your existing balances.

Another form of debt consolidation is offered by consumer credit counseling agencies: debt management. If youre having trouble paying your debts and your credit score isnt good enough to qualify for a debt consolidation loan, you can enlist a credit counselor to work with your creditors to make your debt easier to pay off.

There are a few good reasons to pursue debt consolidation:

Lets take a closer look at a few types of debt consolidation and how they work:

Debt Consolidation Loan: You could reorganize your debts by replacing them with a single debt consolidation loan, which might take the form of a personal loan or home equity loan. You pay off your existing debts, then roll them into the consolidation loan. Debt consolidation simplifies your debt and can cut your interest costs if you qualify for a lower APR (annual percentage rate) than youve been paying on your previous debts.

Credit Card Balance Transfer: If you have good enough credit, you might be able to consolidate debt by transferring your existing balances to a 0% APR balance transfer credit card. Note that the cards are interest-free for a limited time, so you need to make sure you pay off the entire debt before the regular (and often high) APR kicks in.

Debt Consolidation Through Credit Counseling: A nonprofit consumer counseling agency can put you on a debt management plan that will consolidate your debt into one big monthly payment to the agency, which then pays your creditors. You get points for making on-time payments, your credit score wont be affected, and you can save on interest and fees.

Instead of taking out a new loan or working with a credit counseling agency, you could try to renegotiate your debts with your creditors, maybe by asking for a payments pause or a lower interest rate. Theres no guarantee theyll say yes.

Another option is debt settlement, which involves working out a deal with your creditorseither on your own or with the help of a debt settlement companyto pay off your debt in a lump sum for less than you owe. Debt settlement can be risky and can hurt your credit, so its generally not the smartest option.

Bankruptcy is a legal procedure that can wipe out your debts and give you a clean slate, or provide you with a plan to pay off your creditors within three to five years.

The downside is that bankruptcy can stay on your credit report as a black mark for up to a decade, making it harder for you to take out new loans. Not all debts can be discharged, or eliminated, through bankruptcy; back child support, alimony, past-due taxes and student loans usually cannot be erased.

Bankruptcy has consequences and can be an emotionally difficult and lengthy process. However, if your debts are unmanageable and unpayable and you want to make a fresh start at rebuilding your finances, bankruptcy might be the best choice.

Bankruptcy is a form of legal protection for borrowers; its part of the social safety net for consumers who get into money trouble or suffer financial setbacks. But many people might prefer to find another way to deal with overwhelming debt.

Americans usually have two bankruptcy options to choose from: Chapter 7 and Chapter 13 bankruptcy.

Chapter 7: This type of bankruptcy is intended for people who lack the financial means to make debt payments. Chapter 7 puts a halt to collection efforts and can eventually cancel many kinds of debt. In exchange, the debtor must agree to give up some personal property so it can be sold to pay off creditors, though most assetsincluding home equity, cars and jewelryare usually exempt.

Chapter 13: Often called repayment plan bankruptcy or wage earners bankruptcy, Chapter 13 requires you to agree to make payments to your creditors over the course of three to five years. Once the repayment plan is completed, remaining debt may be forgiven. Debts typically discharged through Chapter 13 bankruptcy include credit card balances, medical debts and other unsecured personal debts.

As part of the bankruptcy filing process, debtors are required to take a credit counseling course. But turning to a nonprofit consumer credit counseling agency is a good idea long before you decide to seek protection from your creditors through the bankruptcy courts.

Credit counseling can help you evaluate your options and explore whether a debt management plan could help you get out of debt without having to go through the bankruptcy process.

Other alternatives to dealing with debt through bankruptcy include: selling some belongings youre no longer using to help pay down what you owe; taking on a part-time job or side hustle to boost your income; and borrowing money from family and friends to repay your creditors. But be careful with that last one, because if you dont pay back a friend or relative you risk ruining the relationship.

Bankruptcy marks you in the eyes of the financial industry as a borrower who is not creditworthy, and that negative mark stays on your credit report for seven years in the case of Chapter 13 bankruptcy, and 10 years when you file Chapter 7.

Meanwhile, debt consolidation can help improve your credit. A debt consolidation loan pays off your existing balances and leaves you with one monthly bill. A loan with a lower APR can allow you to save money and find extra room in your monthly budgetmaking your debt easier to handle.

To answer that question and make the right choice for your situation, compare your options side by side.

When debt is a problem, you may find that neither debt consolidation nor bankruptcy is the right solution.

Heres another idea: Consult a consumer credit counseling agency. These nonprofit organizations can help you understand your options and will recommend a plan to get you out of debt.

If you dont have good credit and may have trouble qualifying for a lower-APR debt consolidation loan, a credit counselor can provide expert advice and work with you to come up with a debt management plan. The counselor also can help you explore whether bankruptcy is the best choice for your situation.

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Filing for bankruptcy is a multistep process that requires you to pull together tax returns and other documents, attend mandatory credit counseling sessions, fill out lots of forms, and go to the U.S. bankruptcy court for your ZIP code with your paperwork and required fees (again, $338 for Chapter 7 and $313 for Chapter 13) in hand.

You can file for bankruptcy on your own, without an attorney, but thats not recommended. Free legal assistance may be available if you qualify.

Whether you file for Chapter 7 or Chapter 13 bankruptcy, the process is complex and can take anywhere from a few months to more than a year.

In a Chapter 7 proceeding, the judge might require you to surrender some personal possessions to pay creditors. In a Chapter 13 case, youll have to agree to a repayment plan to give back some of the money you owe over the next few years.

A bankruptcy attorney can navigate you through it all, and help you understand what to expect.

A Chapter 7 bankruptcy stays on your credit report as a black mark for up to 10 years. A Chapter 13 bankruptcy will remain on your credit report as negative information for as long as seven years.

Theres no specific limit on the number of times you can file for bankruptcy, though you can receive debt relief from bankruptcy only once every several years.

For example, if you filed for Chapter 7 bankruptcy, you cannot discharge debts again via Chapter 7 for eight years. If you used Chapter 7 previously, you must wait four years to try to discharge more debts via Chapter 13.

Rolling your debts into a lower-interest debt consolidation loan is trickier if you have bad credit. A lender may look at your lackluster credit score, assume youll have difficulty repaying the loan and reject your application. The best debt consolidation loans for bad credit tend to come from online lenders that are more willing to say yesif youre willing to accept a higher interest rate.

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Debt Consolidation Vs. Bankruptcy: What Is The Difference? Forbes Advisor - Forbes