Bankruptcy vs. Credit Counseling: What's the Right Choice for You?

Entering into 2024, American households held record consumer debt. This debt includes auto loans, personal loans, mortgages, and student loans. But the most significant increase was in credit card debt.

You may have success negotiating with your creditors and lenders. You may find a lower interest rate in refinancing your mortgage or shopping around for special deals on credit transfers to lower your monthly payments. But if you can't manage by yourself, you are not alone. Credit counseling might be valuable.

Bankruptcy or Credit Counseling?

A credit counseling agency may be the right choice if you have a steady income and can repay your debt with some assistance. But if your debt is overwhelming and you have difficulty paying or have fallen behind, you may consider Chapter 7 or Chapter 13 bankruptcy.

Bankruptcy has two primary forms: liquidation with Chapter 7 bankruptcy and repayment with Chapter 13. Chapter 7, if you qualify, will discharge or dismiss certain obligations. This includes unsecured debts, personal loans, medical debt, and credit cards. All non-exempt property is to be sold to pay your debts. The remainder is eligible for discharge.

Chapter 13 works with your creditors to devise a repayment plan over three to five years. You will make one monthly payment. If you complete your payment plan, your remaining debt is eligible for discharge.

Credit counseling requires you to repay all debts over time—it's more of an educational push in the right direction. It's an important step. You must complete credit counseling before filing for bankruptcy.

What Is Credit Counseling?

Credit counseling is an excellent way for those in debt to solve bigger-picture financial questions while managing day-to-day cash flow challenges.

You'll receive education from a certified credit counselor during your credit counseling sessions. You will learn about:

• Making a monthly payment to repay debt faster
• Improving your credit score and credit report
• Devising an overall debt repayment plan
• Budgeting to stay debt-free in the future
• Having money management skills
• Knowing credit repair tactics

Credit counselors may be in person at local offices, online, or via phone. Contact your bank, credit union, or consumer protection agency to find one near you. They can help you learn about budgeting, focus on paying down debts, and work with your credit card companies.

Military bases, housing authorities, universities, and credit unions usually offer free credit counseling. You can also contact the National Foundation for Credit Counseling (NFCC), a nonprofit organization that provides consumer credit counseling referrals and services.

Credit Counseling When Filing for Bankruptcy

People filing for bankruptcy must get debt and credit-related financial counseling up to 180 days before filing. The U.S. Trustee Program provides a list of approved credit counseling providers, but be sure to research your chosen course.

In most cases, you will also attend bankruptcy counseling courses after filing for bankruptcy. These courses focus on debtor education to stay debt-free in the future.

Choosing Your Credit and Debt Counseling Organization

Legitimate credit counselors typically offer free credit educational courses and services. They are usually accredited nonprofit credit counseling agencies.

Credit counselors can provide advice on managing debt and developing a budget. Credit counselors will explore your entire financial situation even if you choose counseling services for a specific issue.

Ask your bank or credit union for reputable businesses they recommend. Look for accredited nonprofit credit counseling services. Check these services with your local consumer protection agency and the Better Business Bureau. You can also check with your state attorney general's office.

Overall, they should help you devise personalized, long-term solutions. The first consultation, which may be free of charge, typically lasts about an hour.

Avoiding Credit Counseling Scams

Debt counseling companies can look legitimate but are scams. Even if they say they are nonprofit, they may not offer legitimate services. Never give credit card numbers or personal information to a debt counseling company until you are sure it is a legitimate business.

• All credit repair companies must give you a copy of the Consumer Credit File Rights Under State and Federal Law document. This document details your rights. You have the right to check your credit report and dispute errors, cancel your contract with the credit repair agency within three days, and sue the credit repair agency if they violate these rights.

• Credit repair companies, by law, can't charge you before providing service. If the company tries to make you pay upfront, they are not a legitimate credit repair or counseling service.

• Avoid companies trying to push you into debt settlement. A debt settlement company is not the same as credit counseling or credit repair. This is not counseling, and it does not dismiss your debts. These companies offer debt consolidation by negotiating with creditors, rolling all debts into one account, and "paying off" your debt in one lump sum. But they'll make you pay them back at a high interest rate. In some cases, this can put you more in debt.

• Some organizations will not provide free service information until you submit personal details. This practice often indicates a fraudulent or unprofessional agency. You should do your research before committing to find a reputable counseling service.

• Trust your instincts. If the agency offers services and resolutions that sound too good to be true, they probably aren't real. Getting out of debt is a process. There is no quick fix.

What To Ask When Choosing a Credit Counseling Organization

Not all consumer counseling services are equal. The least reputable ones can harm your financial goals. To make an informed decision, you should ask the following questions before choosing one:

• What services do you offer? Avoid organizations that insist on debt management programs or debt management plans (DMPs) before they have reviewed your finances. Instead, look for organizations offering debt management classes and budget counseling.

• Is there a charge for educational materials? What other information do you offer? Organizations that charge for general information are often unreputable, even if they claim to be nonprofit credit counselors.

• Will you help me devise a personalized plan for my personal finance situation in addition to solving my specific issue? Whatever they say, get it in writing. Staff can say anything and then hand you a different contract later. Save yourself time and money by getting their contract right away in writing.

• Are there payment options if I can't afford your fees? Organizations that turn people away because of a lack of funds are often unreputable.

• Will I sign a formal, written contract for your services? Only sign documents that you have read and fully understand. Get all verbal offers and agreements in writing.

• Do you have a license or accreditation to offer your services in my state? Are your counselors accredited or certified by an outside organization? If not, what is your training policy? Choose an organization with counselors trained by a third party.

• How is my personal information, such as my birth date, address, and Social Security number, kept confidential? The agency should secure your personal information and not sell it to other services.

• How do you compensate your employees? If employees get paid more when you agree to services, pay a fee, or contribute to the organization, they may not be considering your best interests.

When To Hire an Experienced Bankruptcy Attorney

When financial problems become severe enough to stress your personal and family life, it may be time to take legal action to improve the situation. You do not need an attorney if you want to start with a credit counseling service as your debt relief option. But if the company seems like a scam, they may steal your personal information. Or if there's a contract issue, you will want an attorney to step in.

If you're considering bankruptcy, some attorneys offer a free consultation to guide you through the process. Meeting with an attorney to discuss your situation and explore your legal options is a good way to try to obtain a favorable outcome. Find a bankruptcy and debt attorney or law firm to help resolve your debt situation.