Debt consolidation vs. bankruptcy: What’s the difference? (2024)

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Debt consolidation vs. bankruptcy: What’s the difference? (1)

Debt consolidation with a personal loan or bankruptcy: Both are debt solutions, but one is better than the other. (Shutterstock)

Debt consolidation and bankruptcy are two options for dealing with overwhelming debt. Both provide a long-term solution to your debt, but they work very differently and have varying credit consequences.

Debt consolidation vs. bankruptcy

Both debt consolidation and bankruptcy can help you manage debt, but it’s important to understand how each one works before deciding which option makes sense for you. Here are some key differences between debt consolidation and bankruptcy.

Debt consolidation

Debt consolidation merges multiple debts into one, usually by taking out a new loan or 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 are having trouble managing multiple monthly payments or high interest rates.

Debt consolidation may harm your credit in the short term since it requires taking on new debt. But it can boost your credit in the long run as you pay off your debt. Debt consolidation may have a small cost associated with it in the form of a loan origination fee or balance transfer fee, if you’re using a balance transfer credit card to consolidate.

The amount of time it’ll take you to get rid of your debt depends on the debt consolidation route you choose, the amount of debt you have, and the amount you can afford to pay each month. But it may be possible to be debt-free within five years.

Bankruptcy

Bankruptcy is another debt solution, but with a very different process and different ramifications. Unlike debt consolidation, bankruptcy is a legal proceeding. And instead of helping you consolidate your debts or get lower interest rates, it helps you get rid of your debts altogether.

If that sounds too good to be true, know there are serious downsides. First, not all types of debt can be discharged in bankruptcy, so you may still find yourself stuck with some of the debt.

What to know about debt consolidation

In most cases, debt consolidation involves taking out a personal loan to pay off your other debts. You’ll then only have one debt with one monthly payment to worry about. In some cases, you may qualify for a lower interest rate than what you were paying on your other debts, which can also save you money in the long run.

Pros of debt consolidation

Streamlines debt repayment — Debt consolidation can help you go from multiple monthly payments and interest rates to just one. Not only is it easier to keep track of your debts, but you could also end up paying less each month.
May get a lower interest rate — Debt consolidation can result in a lower interest rate, especially if you’re consolidating high-interest debt like credit cards or using a secured debt like a home equity loan to consolidate your debt.
Can improve your credit — While you may see a temporary drop when you open the new debt, debt consolidation may improve your credit utilization and make it easier to make on-time payments each month.
Get out of debt sooner — With a potentially lower monthly payment and interest rate, debt consolidation could help you pay off your debt more quickly. Depending on how much debt you have, it could take as much as several years or as little as a few months to become debt-free.

Visit Credible to compare personal loan rates from various lenders, without affecting your credit.

Cons of debt consolidation

May pay fees — Debt consolidation may come with added costs in the form of an origination fee on a personal loan or home equity loan, or a balance transfer fee on a credit card. Factor in the additional fees to make sure that consolidating your debt will make financial sense.
Interest rate may not be lower — There’s no guarantee that debt consolidation will result in a lower interest rate. Personal loans can have high interest rates, especially for borrowers with poor credit. If you already have low interest rates on your current debts, then consolidating the debt might not be advantageous.
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, meaning your lender could foreclose on your home if you stop making your payments.
May not get to the root cause of spending — If you haven’t addressed the root cause of your debt, then your debt consolidation loan could help you pay off your credit cards but tempt you to use them for additional purchases. As a result, you may find yourself in an endless debt cycle.

What to know about bankruptcy

If your financial situation is dire and you’re considering bankruptcy, these are the two different types:

Chapter 7 bankruptcy — This type of bankruptcy allows you to have certain debts discharged. In return, your non-exempt possessions will be sold to help provide some compensation to your creditors. What’s considered exempt property depends on your state but could include work-related items, a personal vehicle, equity in your personal residence, and home furnishings.
Chapter 13 bankruptcy — With Chapter 13 bankruptcy, a court representative will help you create a repayment plan rather than discharging your debts. You’ll make installment payments to your creditors for a certain number of years, and in exchange you can keep all your property. Any remaining debt at the end of the repayment term will be discharged.

It’s important to note that some debt can’t be discharged in Chapter 7 bankruptcy. Debt that won’t be discharged includes child support, alimony, taxes, and student loans. Chapter 7 bankruptcy also has an income limit. Those who wish to file for bankruptcy and aren’t eligible for Chapter 7 can use Chapter 13 instead.

Pros of bankruptcy

Can provide debt relief — Bankruptcy can provide relief from your debt and, in the case of Chapter 7 bankruptcy, help you discharge some of your debts entirely.
May help you avoid foreclosure — Bankruptcy can help you avoid legal judgment or foreclosure as a result of unpaid debts.
Some possessions will be taken — While some of your personal possessions will be liquidated to pay off credits, others will be exempt from liquidation.
May not lose all your possessions — In the case of Chapter 13 bankruptcy, you may be able to keep your possessions while still having some of your debts discharged.

Cons of bankruptcy

Lasting credit effects — Bankruptcy remains on your credit report for up to 10 years and could prevent you from borrowing money, renting an apartment, qualifying for insurance, or even getting certain jobs.
Could lose your possessions — Depending on the type of bankruptcy, you could end up having many of your personal possessions taken and liquidated to make payments on your debts.
Not every debt is eligible for discharge — Certain debts, including student loans and child support, aren’t eligible to be discharged during bankruptcy.
May have to pay fees — Bankruptcy can result in additional court, administrative, and attorney fees during a time when you’re already struggling to pay what you owe.

Bankruptcy should be considered as a last resort. Consider a personal loan for debt consolidation instead. You can quickly and easily compare personal loan rates with Credible to find one that suits your needs.

Introduction

As an expert in personal finance and debt management, I can provide you with valuable insights on the concepts mentioned in the article you shared. With my knowledge and experience, I can help you understand the differences between debt consolidation and bankruptcy, as well as the pros and cons of each option. Let's dive into the details!

Debt Consolidation

Debt consolidation is a strategy that involves merging multiple debts into one, typically by taking out a new loan or using a balance transfer credit card to pay off existing debt balances. This approach is beneficial for individuals who can afford to pay off their debt but struggle with managing multiple monthly payments or high interest rates.

Pros of Debt Consolidation:

Streamlines debt repayment: By consolidating your debts, you can simplify your financial obligations by having only one monthly payment to worry about. This makes it easier to keep track of your debts and may even result in paying less each month.
Potential for lower interest rates: Debt consolidation can lead to a lower interest rate, especially if you're consolidating high-interest debt like credit cards or using a secured debt like a home equity loan.
Improved credit: While there may be a temporary drop in your credit score when you open a new debt, debt consolidation can improve your credit utilization and make it easier to make on-time payments each month.
Faster debt payoff: With a potentially lower monthly payment and interest rate, debt consolidation can help you pay off your debt more quickly, potentially within a few months to several years.

Cons of Debt Consolidation:

Potential fees: Debt consolidation may come with additional costs such as origination fees on personal loans or home equity loans, or balance transfer fees on credit cards. It's important to factor in these fees to ensure that consolidating your debt makes financial sense.
No guarantee of lower interest rates: There is no guarantee that debt consolidation will result in a lower interest rate. Personal loans, especially for borrowers with poor credit, can have high interest rates. If you already have low interest rates on your current debts, consolidating the debt might not be advantageous.
Risk to assets: Depending on the type of debt consolidation you choose, you may be putting certain 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 payments.
Addressing the root cause of spending: Debt consolidation may help you pay off your credit cards, but if you haven't addressed the root cause of your debt, you may find yourself in an endless debt cycle.

Bankruptcy

Bankruptcy is a legal proceeding that provides a way to eliminate or restructure your debts. There are two main types of bankruptcy: Chapter 7 and Chapter 13.

Chapter 7 Bankruptcy: Chapter 7 bankruptcy allows you to have certain debts discharged. In return, some of your non-exempt possessions may be sold to provide compensation to your creditors. The specific exemptions for what property can be kept vary by state but may include work-related items, a personal vehicle, equity in your personal residence, and home furnishings.

Chapter 13 Bankruptcy: Chapter 13 bankruptcy involves creating a repayment plan with the help of a court representative. Instead of discharging your debts, you make installment payments to your creditors for a certain number of years. At the end of the repayment term, any remaining debt is discharged. Unlike Chapter 7, you can keep all your property in Chapter 13 bankruptcy.

Pros of Bankruptcy:

Debt relief: Bankruptcy can provide relief from your debt and, in the case of Chapter 7 bankruptcy, help you discharge some of your debts entirely.
Foreclosure avoidance: Bankruptcy can help you avoid legal judgment or foreclosure resulting from unpaid debts.
Exemption of certain possessions: While some of your personal possessions may be liquidated to pay off creditors, others will be exempt from liquidation, depending on the type of bankruptcy.

Cons of Bankruptcy:

Lasting credit effects: Bankruptcy remains on your credit report for up to 10 years and can impact your ability to borrow money, rent an apartment, qualify for insurance, or even secure certain jobs.
Potential loss of possessions: Depending on the type of bankruptcy, you may lose many of your personal possessions, which will be taken and liquidated to make payments on your debts.
Ineligible debts for discharge: Certain debts, such as student loans and child support, cannot be discharged through bankruptcy.
Additional fees: Bankruptcy can result in additional court, administrative, and attorney fees, which can further strain your financial situation.

It's important to note that bankruptcy should be considered as a last resort. Exploring alternatives like debt consolidation through a personal loan may be a more suitable option for many individuals.

I hope this information helps you understand the concepts discussed in the article. If you have any further questions or need additional clarification, feel free to ask!