Bankruptcy vs. Debt Relief

Consumer debt reached record highs in 2024. This includes all types of debt, such as medical debt, student loans, and mortgages. The most significant increase is in credit card debt. This is not surprising. The economy has struggled, and the COVID-19 pandemic impacted many of us in multiple ways. Many rely on credit cards to help fill in the gaps.

You may feel overwhelmed if you struggle with debt or cannot pay it. You are not alone. Multiple debt relief options, including bankruptcy, are available if appropriate.

Bankruptcy and debt relief are similar. Both options offer guided programs to help people get out of debt.

What Is Bankruptcy?

Bankruptcy is a legal path to discharge certain kinds of debt. Chapter 13 bankruptcy is sometimes called the “wage earner" plan. Under the supervision of the Bankruptcy Court and a U.S. Trustee, you and your creditors reorganize your debts and establish a repayment plan. A single payment is set for three to five years, at the end of which your remaining balance is eligible for discharge.

Chapter 7 bankruptcy is a liquidation plan. It's more challenging to qualify for because you must meet what is known as a means test. In Chapter 7, a trustee helps sell off eligible assets to repay creditors. The Court will discharge the remaining balance.

What Is a Debt Relief Program?

Debt relief includes various programs or plans to get you out of debt without declaring bankruptcy. In these programs, you learn budgeting skills and money management to help you live debt-free. Often, these programs can negotiate a lower interest rate or payment plan with your creditors and lenders. 

However, many companies claiming to help with your debt are frauds and worsen your situation. Choosing a debt relief program should be a careful process. Either path can be right for you, but it is important to understand debt relief's pros and cons.

Creditor Harassment Won't Stop With Debt Relief

Debt relief programs are not a legal end to creditor harassment. That occurs during bankruptcy. Once a bankruptcy petition is filed, there is an automatic stay of actions against the debtor. This stay stops all legal actions against you, including foreclosure. Under a debt relief program, creditors can still call and ask for their payments.

Creditors Are Not on Your Side

You should be cautious of a debt relief program offered by a creditor or credit card company. They are not working in your best interests and their goal is to settle their own debt.

Bankruptcy can have advantages because your bankruptcy attorney is on your side. The trustee is charged with upholding the bankruptcy laws in dealing with the debtor and its creditors. Their goal is to help find a lasting debt resolution. The debtor has its own attorney in most instances and also has neutral, third-party resources that may assist in guiding the debtor to a fresh start.

Creditors might say only specific debt programs will work for your debt, but this is untrue. You might have many more options available, including bankruptcy.

Focusing on Certain Debts

Debt relief programs may focus on one creditor or a small part of your debt. This may not be helpful if you have many credit cards or medical debt. Through the U.S. Bankruptcy Code, you have the option to:

  • Discharge multiple debts in Chapter 7 bankruptcy, except you will not discharge debts like student loans, child support, or alimony
  • Create an effective repayment plan for all your debt in Chapter 13 bankruptcy

Entering into bankruptcy shouldn't be a quick decision, as it has serious ramifications for your credit rating.

Both Options Lower Your Credit Score

Your credit score demonstrates to lenders, some employers, and leasing agents how well you manage your money. A low credit score means you may not repay your obligations and pose a financial risk.

Your credit score lowers each month when you cannot make your debt payments. While having some debt helps build your credit, not paying it back each month or having missed payments is damaging. Each month of unpaid credit card debt will lower your score. In addition, declaring bankruptcy reduces your score right away.

However, bankruptcy can eliminate more debt. The bankruptcy will impact your credit for five to seven years, but you can improve your credit score over time.

Common Debt Relief Plans

There are do-it-yourself planning options and companies or professionals who work to help you get out of debt. Credit counseling courses can help you understand your debt and, in some cases, get you back on your feet. If your debt is becoming too high to manage, you may need to consider bankruptcy or debt relief options.

Lump Sum Payments

Some creditors will accept less money than you owe if you offer a large lump sum instead. For example, if you owe $10,000 in debt, the company knows it will take years to see that money. Still, you could offer a lump sum one-time payment so the company sees some of their money, rather than risk losing more through liquidation bankruptcy.

You need to consider:

  • Will the creditor negotiate on the sum? They are not required to negotiate.
  • Will the creditor cancel the remaining debt in full once you pay?
  • Can you afford this payment and monthly expenses?
  • Will a lump sum put your property or assets at risk if you go bankrupt later on? Some 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.
  • You will pay extra taxes. The IRS may consider the amount of loan forgiven to be income, and it is taxable.

You may negotiate a lump sum settlement with your creditors or use a debt relief company.

Debt Consolidation Loans

A debt consolidation loan will pay off all your creditors to stop interest and harassment. This personal loan can help overwhelmed people organize their debt into one payment. If your credit score is adequate, you may find attractive interest rates that make a debt consolidation loan a sensible choice, It's an option to consider if you have credit cards with high interest rates.

A loan to pay off debts can seem like the answer, but there are consequences to consider:

  • You risk your assets and property if they are used as collateral for the loan. Late payments and missed payments could result in your home or car being seized and sold to cover your debt.
  • You may face a debt lawsuit from the loan company if you cannot pay. A lawsuit means losing your home, car, assets, or anything else used as collateral in addition to paying attorney's fees.
  • Will you be able to afford the debt consolidation loan payment if you cannot afford minimum payments on your original debt? Often, people become deeper in debt after seeking a debt consolidation loan.
  • Interest rates can put you deeper into debt and never help you out of your financial hole.
  • If you don't address your underlying spending issues and learn better money management skills, you may not achieve the financial freedom you hope for.

You can research for and apply for debt consolidation loans on your own or hire a debt consolidation agency. Consolidating debt with a loan can help you focus on one bill rather than many. However, it does not eliminate debt, and you can fall deeper into debt through loans.

Working With a Debt Settlement Company

You can hire or work with companies to consolidate debt. These companies can negotiate with your creditors, complete the consolidation process, and create a debt management plan. Some credit counseling agencies may also offer these services. Note that not all these companies are honest. You must 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 your personal finances
  • 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
  • Legitimate companies may be expensive and require upfront fees and 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
  • It affects your credit report if you cannot make your payments
  • Creditors can change their mind and sue you at any time
  • It can extend the time you spend in debt

Make sure you can handle a new situation before committing to anything.

Nonprofit Credit Counseling Agency

An accredited nonprofit credit counseling agency offers comprehensive debt services, including money management, budgeting, and personal finance courses. If you file for bankruptcy, you must complete credit counseling.

Credit counseling agencies may also offer a debt management plan (DMP). A DMP is similar to a financial agreement in Chapter 13 bankruptcy. Your credit counselor will negotiate with your unsecured creditor and devise a payment plan. You will make one payment to the credit counseling agency, and they will distribute the funds to your creditors.

Finding A Reputable Debt Relief Program

Be wary of debt relief programs that promise easy solutions, demand payment upfront, or pressure you to sign a contract. Getting out of debt takes time. Trust your instincts, and know your rights. Look for a licensed and accredited agency. Counselors should have professional training that's approved by the U.S. Trustee program.

To find a reputable, accredited program:

If a debt relief program takes advantage of you, report the company to the Federal Trade Commission and your state attorney general. You may also consider legal action.

Bankruptcy Should Be a Last Resort

You must attend credit counseling before a bankruptcy filing. Finding an accredited credit counseling program should be your first step, even if you don't file for bankruptcy.

Bankruptcy will not discharge your student loans, child support, alimony obligations, or tax debts.

Chapter 13 bankruptcy requires a repayment plan, so it may not be the right type of bankruptcy if you don't 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. 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.

Is Bankruptcy or Debt Relief Right for Me?

If you're unsure, you should consider consulting with a bankruptcy attorney. 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 for you if your debt is not very large or you have a steady income. Often, filing for bankruptcy is the fastest way to reduce your total debt.

Many people think hiring a bankruptcy lawyer will increase their debt. While you must pay filing fees and attorney's fees that average $500 to $5,000, it can be cost-effective in the long run as your debts are discharged faster.

Considering Bankruptcy or Need Legal Advice? Contact a Bankruptcy Attorney

Being in debt is overwhelming, but the choices available can be just as daunting. Consulting an attorney should be your first step if you are considering bankruptcy. Some offer free initial consultations. A qualified bankruptcy attorney can evaluate your case and provide valuable legal advice. Contact a local bankruptcy attorney for more information.

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