Before bankruptcy can be declared, the government requires persons considering this course of action to go through debt counseling to see if there are any alternatives available. Debt consolidation is a common strategy practice that is brought up in these sessions and is often used as an alternative to bankruptcy. As you begin to explore your options, there will be many questions about what is in fact the best route, as there are pros and cons to both choices. But before we begin evaluating these options, it is important to have a general understanding of how debt consolidation and bankruptcy work.
What is Debt Consolidation
Debt consolidation does precisely what the name implies: multiple debts will be put together into a single debt, with the idea that these debts will be more manageable. The idea is that individuals who are in debt are more likely, and have an easier time, paying on one single debt rather than many.
Say you owe on a credit card $2,200, a car loan for $28,000, and a second credit card for $1,400. With debt consolidation, a new loan would be taken out that would pay off these loans for the amount of $31,600. You would now make the monthly payments into that new loan at the agreed upon rate, which can vary depending on the institution and other economic factors.
It is important not to confuse debt consolidation and debt settlement, as these are two very different concepts. In debt settlement, someone will negotiate on your behalf to your creditors to attempt to get the amount owed reduced.
What is Bankruptcy
Generally, bankruptcy will be either chapter 7 or chapter 13 bankruptcy, each with its own set of benefits and limitations. Briefly, chapter 7 will focus on mostly the elimination of debt while chapter 13 will restructure your debt. Both of these types of bankruptcy will eliminate most of your debt, which means you will no longer responsible for paying on these debts.
Which do I Pick?
This is going to vary greatly depending on your situation and contacting an attorney will help you to evaluate your options efficiently.
Most people will decide to go the route of bankruptcy because it will essentially discharge most of the debts that have been accumulated. As soon as you have declared bankruptcy, your creditors will cease attempting to contact you and all of your payments will cease as well, allowing you some room to breathe. The primary downside of declaring bankruptcy will be the impact it will have on your credit score and the potential loss of assets. This is where having an experienced bankruptcy attorney comes in hand, as most of the time individuals get to keep most of their assets with the right attorney. Re-building a good credit score is also not as daunting of a task as it might sound. Bankruptcy only stays on a credit score for 7-10 years depending on the type of bankruptcy you declare. With bankruptcy, you will have a clean slate, allowing you to get your finances in order and re-build credit.
Debt consolidation will not impact your credit as bankruptcy will, but it is important to remember that while bankruptcy does initially hurt you, it also gives you a base to build from. Typically, if you are in this position your credit is already so severely damaged bankruptcy will not have much of an impact anyway. Debt consolidation also can be harmful as tax time rolls around. The IRS considers the money you have saved from consolidating debt as income, and therefore you will be liable to pay taxes on it. Debt consolidation is beneficial in some instances, typically when there is a large amount of debt, but not an overwhelming amount. Sometimes, restructured payments are all that is needed for you to get out of debt, and that is when this will be most helpful.
Again, these decisions should not be made lightly, and you should evaluate your options before making a decision. Talking to an attorney can help you evaluate your options, and whatever decision you come to, they can help you with the next steps. Every situation will vary, and there are other options outside of the ones listed above that may be beneficial to you. In a case of debt consolidation vs. bankruptcy, most of my clients are able to keep most of their assets while gaining freedom from creditors. The most important thing to remember is that your situation is not hopeless, there are options available to get you back on your feet. Give me a call for a debt assessment, and we can help you get back on your feet.