If you find yourself with debt you are struggling to repay, debt consolidation and bankruptcy are two potential debt relief paths you can take. Before comparing the two, it’s important to understand the basics of debt consolidation and the basics of bankruptcy.
Debt consolidation does just what it sounds like it would do – it lumps, or consolidates, multiple debts into one single amount owed. Generally, this is done by obtaining an unsecured loan, which is used to pay off existing, unsecured debts.
The benefit of debt consolidation is that it reduces the actual amount of money you pay on a monthly basis. Because the new loan has a lower interest rate than the interest rates on your existing debts, you will pay less in interest charges and have more money available to pay down your principal amount. Additionally, debt consolidation tends to make debt relief more manageable and less overwhelming, as it’s much easier to track one monthly payment than several.
Often deemed a last-resort option, bankruptcy is a more complicated process than debt consolidation as they involve lawyers’ fees and a formal judicial procedure.
The two most common types of consumer bankruptcy are Chapter 7 and Chapter 13 filings. Chapter 7 is a liquidation provision, allowing debtors to discharge some or all of their debt. A trustee is assigned to your case to sell your property, aside from certain exempted items, and you can use the resulting cash to pay your debts.
On the other hand, Chapter 13 is a reorganization provision. Through a Chapter 13 filing, you can restructure your debts under a repayment plan supervised by the bankruptcy court. You will gradually pay off a certain portion of your debts and will not be required to pay off the rest.
With both types of bankruptcy, most of your debts, including credit card debt and medical debt, will be discharged, and you will no longer be liable for paying that debt.
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The Key Differences
When deciding which avenue to pursue, here are a few key differences between debt consolidation and bankruptcy that you should consider.
Reducing your Debt Amount
Debt consolidation does not lower the amount of debt you owe: It restructures it so that you pay less interest over time, but the principal amount of debt remains the same. On the other hand, bankruptcy can reduce the total amount you owe, and at times, may exempt you from paying the full amount. This option tends to be best for those whose debts have become so overwhelming that they feel they can no longer manage them.
Credit Report Impact
Because it requires you to continue making your loan payments, debt consolidation does not impact your credit score. Bankruptcy, however, heavily impacts it: In fact, its negative effects remain on your credit report for seven to ten years.
As with any debt relief option, both debt consolidation and bankruptcy carry pros and cons, and may not be the best fit for every financial situation. Reach out to an attorney, financial planner, or other trusted advisor to determine which option, if either, would be best for you.