Debt has become so commonplace for the average American consumer that it can be difficult to spot when the debt has become too much. When debt gets out of control, it can become incredibly overwhelming. If you feel bogged down by your debt or your monthly payments have become unaffordable, it is probably time to do something proactive about your debt.
However, many Americans live paycheck to paycheck which can make it overly challenging to pay off their debt as it is. There are many individuals who find in necessary to file for bankruptcy or pursue debt settlement to find financial relief. There are others who might be able to handle their debt through a consolidation loan or balance transer card so as to avoid any harm to their credit scores.
If you have overwhelming debt, exploring your options more in depth could help you determine which is the better option: debt consolidation vs. bankruptcy.
How Filing for Bankruptcy Works
Bankruptcy is a legal proceeding that is vital to the proper functioning of the American economy. Bankruptcy is designed to provide debt relief to those borrowers who owe more money than they can realistically afford to pay back. It provides a way out for borrowers with too much unsecured debt by wiping their slate clean and offering them a repayment schedule that works for their financial situation.
The bankruptcy process differs depending on the type of bankruptcy that is being filed. The two most common types of bankruptcy for individual filers are Chapter 7 Bankruptcy and Chapter 13 Bankruptcy.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is better known as liquidation bankruptcy as it liquidates your assets to pay off your creditors. To qualify for chapter 7 bankruptcy, you need to be making under a specified gross annual income. After the court-appointed trustee handles the liquidation of eligible assets, all your remaining debt will be discharged fully except for a few exceptions such as student loans.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy acts a bit differently than chapter 7 as it essentially reorganizes your debt rather than erasing it. Also known as the repayment plan chapter, chapter 13 bankruptcy sets up debt management plans for filers so that they can repay at least a portion of their unsecured debts. The single monthly payment assigned to you will depend on what you can afford according to your income. Your existing debts will be slowly paid off over a period of three to five years, and, in some cases, a portion of your unsecured debt may be discharged if it cannot be repaid within a certain amount of time.
How Debt Consolidation Works
Debt consolidation is a debt management solution that takes several high-cost loans or credit cards and combines them into a single balance with a more affordable interest rate and one monthly payment. A debt consolidation program can be an excellent solution to make repayment easier.
Debt Consolidation Loan
A debt consolidation loan all your debt balances into one convenient place so you can have a single interest rate and a single monthly payment instead of having to keep track of many. The best debt consolidation loans will also get you a lower interest rate or reduced monthly payments to make the repayment process more affordable.
A debt consolidation loan can come in a variety of forms. Debt consolidation companies offer loans for the express purpose of debt relief for individuals who need the hands-on help provided in a debt consolidation program. Many individuals choose to use a large personal loan for their debt consolidation, while others turn to secured loans like a home equity loan or home equity line of credit to get even lower interest rates.
Balance Transfer Credit Card
Another way many people choose to consolidate debt is through a balance transfer credit card. A balance transfer card can be incredibly cost-effective for credit card debt if you can qualify for a card that offers a promotional 0% APR. Some credit card companies will offer new customers an introductory promotional period of a 0% annual percentage rate for the first year to 18 months for debt consolidation.
If you use one of these promos offers wisely, the balance transfer card could act as an interest-free debt consolidation loan. All that you need to do is combine your balances onto the card and pay down all of your remaining debt before the end of the promotional period.
This is not the best option for borrowers who have too much debt to reasonably be paid off within a year to 18 months. If the balance can’t be paid off before the promotional period ends, you will be subject to high-interest rates. But if you can aggressively pay off the balance within a year, you could save a fortune on interest costs.
How To Determine Which Is the Better Option: Bankruptcy Vs. Debt Consolidation
Determining whether bankruptcy or debt consolidation is the better option depends entirely on your needs and priorities. How bankruptcy and debt consolidation affect credit differs in that one of them might be more difficult to recover from than the other.
Bankruptcy will remain on your credit report for up to seven to ten years while a debt consolidation loan or balance transfer card could improve your credit if you keep up with your repayment period. If you simply cannot afford to repay your debt even after consolidation, defaulting and collection accounts could be even more detrimental to your credit score than bankruptcy.
Here are some ways you might be able to tell which is right for you:
Bankruptcy Could Be the Better Option If…
Filing bankruptcy should be a last resort option for those who cannot pay their debts another way. If you cannot afford to pay creditors and need a fresh financial start, it might be time to contact a bankruptcy attorney to get their professional opinion.
Debt Consolidation Could Be the Better Option If…
If you think you are able to afford to pay back your debt if it was reorganized and simplified, debt consolidation could be the ideal solution to protect your credit report. A debt relief agency could advise you on what options might be available to you to save money and ease your journey to a debt-free life.
How To Rebuild Your Credit After Bankruptcy
Attempting to recover and rebuild your credit after you file bankruptcy can be an intimidating task. However, it may be less of a challenge than you think as the most significant action it requires is patience. Time and responsible financial choices can help you attain a credit score you never thought you’d be able to reach again.
There are a few helpful things you can do in the aftermath of bankruptcy that will build stability in your credit and overall finances. Here are some suggestions for the first couple years after you file bankruptcy:
Complete Credit Counseling
All those who have filed for bankruptcy are required to complete the free credit counseling course provided by the legal system. It is important to get every bit of knowledge that you can out of these credit counseling sessions. This information will help you learn how to reintegrate credit in a responsible manner so that you don’t end up in the position you were in before.
If you have the ability and resources, you can also pursue further financial education with a nonprofit credit counseling agency to equip yourself with knowledge that will help you attain better stability. Additionally, there is an abundance of free online resources you can utilize to improve your financial literacy.
Avoid Applying for New Credit
After a bankruptcy filing, put a pause on applying for any and all new credit. While it is true that you are unlikely to be approved for new credit directly after bankruptcy, that is not the foremost reason why you should avoid applying for new loans and credit cards. Every time you fill out an application for credit, a hard inquiry shows up on your credit report and brings down your credit rating.
Constantly applying and getting rejected for credit products will make it incredibly difficult to improve your credit score, which should be a priority after bankruptcy. And loans for people with bad credit can have incredibly high-interest rates. Taking a break from applying for a new loan or credit card will give your credit reports time to recover from the blow they received through the bankruptcy and discharge entries.
Check Your Credit Report Often
Most financial experts recommend that consumers check their credit report as often as they are able to catch any errors or inconsistencies. Every consumer has a legal right to receive a free credit report from each credit bureau annually. It is a good idea to check your credit report more often directly post-bankruptcy, so you can keep your report in the best shape possible while you recover financially.
Checking up on your credit report will also allow you to catch exactly when various debts are discharged or how your debt payments are affecting your score. Monitoring the changes closely will alert you to when you might be ready to apply for new credit or make changes to your strategy.
Use Credit-building Products
If you would like to repair your credit more quickly, you might be under the impression that you can’t actively build credit because you won’t be approved. However, there are credit-building products like secured credit cards and credit-builder loans which may still approve you despite a recent bankruptcy. These lending products are secured with a cash security deposit which enables borrowers with a poor score to build credit by making monthly payments.
By getting a secured credit card or credit-builder loan, you could significantly improve your payment history, which is worth 35%, the largest portion of your credit score calculation. This could give your credit score the final boost you need to be approved for a regular credit card.
Begin Using Credit Responsibly and Sparingly
When you are finally able to qualify for a traditional credit card or loan, it’s important to handle them responsibly so that you don’t end up with overwhelming debt again. Once you start using credit again, start slowly and keep your debt minimal. Pay off your credit card balances every month so that you keep your credit utilization rate low. This will also have the bonus of saving you money on interest charges.
Your credit won’t be repaired overnight after something as significant as bankruptcy. But if you have patience and dedication, you are sure to see results that may surprise you. Once seven to ten years have passed, the bankruptcy will fall off your credit report and your credit score will improve immensely.
Bankruptcy or Debt Consolidation: Which Is Better for You? | Experian
Debt Consolidation v. Bankruptcy: Which is Better? | Nolo
Debt Consolidation Vs. Bankruptcy: What Is The Difference? | Forbes Advisor