Bankruptcy vs. Debt Relief
Bankruptcy and debt relief have some similarities — both options have guided programs to help you get out of debt.
Bankruptcy is a legal path where you file in court and work with a trustee to discharge or pay back some debts. Debt relief includes various programs or plans to get you out of debt without declaring bankruptcy.
Either path can be right for you, but it is important to understand debt relief's pros and cons.
Creditor Harassment Does Not Stop With Debt Relief
Debt relief programs are not a legal end to creditor harassment. That is only a legal option during bankruptcy once your case is approved. Creditors must stop harassing you once you file for bankruptcy, but they can still call and ask for their payments during a debt relief program.
Creditors Are Not on Your Side
If a creditor or credit card company is offering a debt relief program, you should be wary. They are not working in your best interests and are only interested in their own debt settlement.
Bankruptcy can have its advantages because your bankruptcy attorney and bankruptcy trustee are on your side and want to help you find lasting debt relief. It can be helpful to have these advocates as neutral, third-party resources guiding you to a fresh start.
Creditors might say only specific debt programs will work for your debt, but this is not true — there might be multiple options available to you, including bankruptcy.
Focusing on Some Debt vs. Lump Sum Debt
Debt relief programs tend to focus on one creditor or a small part of your debt. This may not be helpful if you have numerous credit cards or medical debt from various places. Through the U.S. Bankruptcy Code, you have the option to:
- Discharge multiple debts in Chapter 7 bankruptcy (but not certain debt like student loans or child support)
- Create an effective repayment plan for all your debt in Chapter 13 bankruptcy
Both Options Lead to Low Credit Score
Your credit score lowers every time you cannot pay debts each month. While having some debt is useful to build your credit, not paying it back each month is risky. Month after month of unpaid credit card debt will lower your score over time, whereas declaring bankruptcy will lower your score right away.
Through bankruptcy, however, more of your debt can go away, which can lead to improvements in your credit score over time.
Common Debt Relief Plans
There are DIY planning options and companies or professionals who work to get you out of debt. Credit counseling courses can help you understand your debt and get you back on your feet in some cases. If your debt is becoming too high to manage, you may need to consider bankruptcy or one of these debt relief options.
Lump Sum Payments
Some creditors will accept less money than you owe if you offer a large lump sum instead. If you owe $10,000 in debt, the company knows it will take them years to see that money when you are in debt. They may like that idea since they will gather interest every month. But in some cases, you could offer a lump sum one-time payment so the company gets their money faster.
You need to consider:
- Will the creditor negotiate on the sum? (They are not legally required to negotiate.)
- Will the creditor cancel the debt in full once you make the payment?
- Do you have enough money to cover this payment and monthly expenses?
- Will a lump sum put your property or assets at risk if you go bankrupt later on? (Lump sum payments can turn your unsecured debt into secured debt.)
- What will you do if another creditor pursues a debt lawsuit? Only filing for bankruptcy can stop a debt lawsuit.
- Can you pay extra taxes on the lump sum payment? The payment will go to the IRS as income, and you may be taxed on it.
Debt Consolidation Loans
A debt consolidation loan will pay off all your creditors at once to stop interest and harassment, and you will just have one payment going forward. This can help overwhelmed people who feel like they cannot keep their creditors and debt straight. A loan to pay off debts can seem like a no-brainer, but there are consequences you should consider:
- Risking your assets and property if they are used as collateral for the loan. Missing a payment could result in your home or car being seized and sold.
- A debt lawsuit from the loan company if you cannot pay. This means losing your home, car, assets, or anything else used as collateral and paying attorney's fees.
- Affording the debt consolidation loan payment if you could not afford minimum payments on your original debt. Often people just become deeper in debt after seeking a debt consolidation loan.
- High-interest rates put you deeper in debt and never help you out of the financial hole you are in.
Consolidating debt with a loan can help you focus on one bill rather than many. However, it does not eliminate debt, and often people find themselves falling deeper into debt through the loan.
Working With a Debt Settlement Company
There are companies you can hire or work with to consolidate debt. They can negotiate with your creditors, complete the consolidation process, and work on a debt management plan for you. Some credit counseling agencies may also offer these services. Note that not all of these companies are honest; you need to watch out for scams.
Pros of debt settlement companies:
- You don't have to spend time consolidating or negotiating
- Your credit counselor can educate you on improving personal finance
- Paying back a large amount of debt can feel more achievable with support
- They can handle calls or other harassment from debt collectors
Cons of debt settlement companies:
- Some of these companies are scams and should be avoided and reported
- The legit companies may be expensive and require upfront fees and monthly payments for their services
- Creditors might refuse to work with the company or refuse to agree to a debt settlement plan
- Companies cannot stop wage garnishment
- Debt like medical bills and credit cards are not dismissed
- Your credit report will still be affected if you cannot make monthly payments
- Creditors can change their mind and sue you at any time
- It can extend the time you spend in debt
Is Bankruptcy or Debt Relief Right for Me?
Have an attorney explain your state's exemptions and bankruptcy laws, and give you honest feedback on your financial situation. A debt settlement program could be the right step for you if your debt is not very large or you have a steady income. In many cases, filing a bankruptcy case is the fastest way to bring down your total debt.
Chapter 13 bankruptcy requires a repayment plan, so it may not be the right type of bankruptcy if you do not have a steady income. It can help people who want to stop creditor harassment and need more time to pay down their debt. Chapter 7 bankruptcy will dismiss unsecured debts, and you do not need to pay them back. It also requires creditors to follow bankruptcy laws, helps control asset repossession, and can rebuild creditworthiness as you make new payments on time.
Many people think hiring a bankruptcy lawyer will increase their debt. While you must pay filing fees and attorney's fees (from $500 to $5,000 on average), it can be cost-effective in the long run as your debts are fully discharged faster.