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Debt consolidation and bankruptcy are two options for dealing with overwhelming debt. Both offer a long-term solution to your debt, but they work very differently and have varying consequences for credit.
Debt consolidation vs bankruptcy
Debt consolidation and bankruptcy can both help you manage your debts, but it’s important to understand how each works before deciding which option is right for you. Here are some key differences between debt consolidation and bankruptcy.
Debt consolidation merges multiple debts into one, usually by taking out a new loan or a balance transfer credit card to pay off your existing debt balances. This option is best suited for those who can pay off their debt but have difficulty managing multiple monthly payments or high interest rates.
Debt consolidation can hurt your credit in the short term since it requires taking on new debt. But it can increase your long-term credit as you pay off your debt. Debt consolidation may have a small associated cost in the form of loan origination fees or balance transfer fees, if you are using a balance transfer credit card to consolidate.
How long it will take to get rid of your debts depends on the debt consolidation route you choose, how much debt you have and how much you can afford to pay each month. But it may be possible to be debt free within five years.
Bankruptcy is another solution to debt, but with a very different process and different ramifications. Unlike debt consolidation, bankruptcy is a legal proceeding. And instead of helping you consolidate debt or get lower interest rates, it helps you get rid of debt altogether.
If it sounds too good to be true, know that there are some serious downsides. First, not all types of debt can be discharged in bankruptcy, so you may still find yourself stuck with some debt.
In most cases, debt consolidation involves take out a personal loan to settle your other debts. You will then have only one debt with only one monthly payment to settle. In some cases, you may qualify for a lower interest rate than you’re paying on your other debts, which can also save you money in the long run.
Debt consolidation can also be done in other ways, including using a balance transfer card to manage credit card debt or a home equity loan or home equity line of credit (HELOC) to pay off your debt.
Advantages of debt consolidation
- Streamlines debt repayment — Debt consolidation can help you go from multiple monthly payments and interest rates to one. Not only is it easier to track your debts, but you might also end up paying less each month.
- Can get a lower interest rate — Debt consolidation can lead to lower interest rateespecially if you are consolidating high interest debt like credit cards or using secured debt like a home equity loan to consolidate your debt.
- Can improve your credit — Although you may see a temporary drop when you open new debt, debt consolidation can improve your credit usage and make it easier to make on-time payments each month.
- Getting Out of Debt Earlier — With a potentially lower monthly payment and interest rate, debt consolidation could help you pay off your debt faster. Depending on the amount of your debts, it can take up to several years or as little as a few months to become debt free.
Visit Credible for compare personal loan rates from various lenders, without affecting your credit.
Disadvantages of debt consolidation
- May pay fees — Debt consolidation may incur additional costs in the form of origination fees on a Personal loan or a home equity loan, or a balance transfer fee on a credit card. Consider additional fees to ensure that consolidating your debt will make financial sense.
- The interest rate cannot be lower — There is no guarantee that debt consolidation will result in a lower interest rate. Personal loans can have high interest rates, especially for borrowers with bad credit. If you already have low interest rates on your current debts, debt consolidation might not be beneficial.
- Assets could be at risk — Depending on the type of debt consolidation you use, you could be putting other assets at risk. For example, a home equity loan is secured by your home, which means your lender could foreclose on your home if you stop making your payments.
- May not reach root cause of expense — If you haven’t addressed the root cause of your debt, your debt consolidation loan could help you pay off your credit cards, but encourage you to use them for additional purchases. As a result, you can find yourself in an endless cycle of debt.
What you need to know about bankruptcy
If your financial situation is dire and you are considering bankruptcy, here are the two different types:
- Chapter 7 Bankruptcy — This type of bankruptcy allows you to pay off certain debts. In return, your non-exempt assets will be sold to help provide compensation to your creditors. What is considered exempt property depends on your state, but can include work-related items, a personal vehicle, equity in your personal residence, and household furniture.
- Chapter 13 Bankruptcy — With Chapter 13 bankruptcy, a court representative will help you create a repayment plan rather than paying off your debts. You will pay installments to your creditors for a number of years and, in exchange, you will be able to keep all your assets. Any outstanding debt at the end of the repayment term will be discharged.
It is important to note that some debts cannot be discharged in a Chapter 7 bankruptcy. Debts that will not be discharged include child support, alimony, taxes, and student loans. Chapter 7 bankruptcy also has an income limit. Those who wish to declare bankruptcy and are not eligible for Chapter 7 can use Chapter 13 instead.
Advantages of bankruptcy
- Can provide debt relief — Bankruptcy can relieve you of your debt and, in the case of a Chapter 7 bankruptcy, help you pay off some of your debts entirely.
- Can help you avoid foreclosure — Bankruptcy can help you avoid a legal judgment or foreclosure due to unpaid debts.
- Some goods will be taken – While some of your personal assets will be liquidated to pay off loans, others will be exempt from liquidation.
- May not lose all your possessions — In the event of a Chapter 13 bankruptcy, you may be able to keep your assets while having some of your debts discharged.
Disadvantages of bankruptcy
- Sustainable credit effects — Bankruptcy stays on your credit report for up to 10 years and could prevent you from borrowing money, renting an apartment, getting insurance, or even getting certain jobs.
- Could lose your property — Depending on the type of bankruptcy, you could end up with a lot of your personal assets seized and liquidated to make payments on your debts.
- Not all debts are eligible for discharge — Certain debts, including student loans and child support, cannot be discharged in bankruptcy.
- May have to pay a fee — Bankruptcy can result in additional court, administrative and attorney fees during a time when you are already struggling to pay what you owe.
Bankruptcy should be considered a last resort. Consider a personal debt consolidation loan instead. You can quickly and easily compare personal loan rates with Credible to find the one that meets your needs.