Money Matters: Debt Consolidation or Bankruptcy?

Are you struggling to keep up with paying off your debts? Is your money situation stressing you out?

It may be time to be brutally honest with yourself and look at how likely it is that you will actually pay off your debts.

Luckily, you have options! If you have enough income, you could consolidate your debts and streamline your finances. If your money is so out of whack that there’s no way to fix it, you can opt for bankruptcy.

However, each option comes with its own pros and cons so it’s important to understand the differences between the two before making such a serious decision.

Struggling with debt and getting behind can have serious consequences. From having bad credit to not being able to co-sign on a student loan for your kid, it’s best you take control of the situation and explore the avenues that can lead you to financial freedom.

Here is a guide to debt consolidation and bankruptcy to help get you started:

What is Debt Consolidation?

Debt consolidation involves obtaining a new loan to pay off smaller loans, debts, or bills that you are currently making payments on. Basically, it’s one combined loan with one monthly payment.

Because each loan is a contract with its own interest rate and repayment terms, you technically can’t “combine” them. This is why debt consolidation requires you to get a new, larger loan and use that money to pay off your smaller debts.

You can use debt consolidation to get rid of loans, credit card balances, overdraft balances, bills, and payday loans.

Debt consolidation loans are issued by banks, finance companies, and credit unions.

When it comes to interest rates, those for debt consolidation loans are determined by two things:

  1. Your credit score.
  2. The collateral you can offer for the loan.

Collateral for a loan is what you agree to give the lender if you are unable to repay the loan. This can include real estate and vehicles.

If your credit score is good, you may not need to use collateral to secure a debt consolidation loan. 

But the better the collateral you can offer, the lower your interest rate will be. You can also look to banks and credits unions who tend to offer lower interest rates than other financial companies.

Reasons to Choose Debt Consolidation

  • It can simplify your finances since you only have to keep track of one payment per month.
  • You can save money by reducing your interest rate on the money you owe.
  • You can extend the period of time you repay the loan and lower your monthly payments.
  • You can pay off your debt faster.

The Disadvantages of Debt Consolidation

  • It won’t solve all of your financial problems because it doesn’t guarantee that you won’t go into debt again.
  • There may be up-front costs and fees such as loan origination fees, balance transfer fees, closing costs, and annual fees.
  • You could end up paying a higher interest rate if your credit score is not good or you need a longer loan term (which could increase the interest rate).
  • If you miss payments, you could be charged a late payment fee and your credit score could suffer some serious damage.

What is Bankruptcy?

Bankruptcy is a legal proceeding you can use if you are unable to repay your debts. It allows you to start fresh with your finances.

The bankruptcy process begins by filing a petition through a trustee where your assets are measured and evaluated – and may be used to repay a portion of your debt.

The trustee is an independent third party that has been appointed to manage the bankruptcy process. There are usually monthly fees associated with the bankruptcy process that is paid to the trustee.

Once the bankruptcy proceedings are finished, you are relieved of your debt obligations. You will receive a discharge order stating that you are no longer legally required to pay off the debts specified in the bankruptcy.

However, not all debts qualify for bankruptcy including tax claims, child support, alimony, personal injury debts, and debts owed to the government.

Reasons to Choose Bankruptcy

  • Most debts are completely eliminated by bankruptcy.
  • In most cases, you can keep your house, vehicle, and investments.
  • Creditors cannot garnish your wages, take legal action, or make other collections efforts against you.
  • The cost of bankruptcy is based on your income.
  • You do not have to speak to or meet with your creditors.
  • The entire process can be completed in as little as nine months.

The Disadvantages of Bankruptcy

  • You’ll lose your credit cards – many credit card companies will cancel your cards when you claim bankruptcy.
  • Your credit score will be negatively impacted and bankruptcy can stay on your credit report for 5-7 years.
  • It’ll be difficult for you to get a mortgage or a loan.
  • In some cases, you may lose property and real estate.
  • There are some types of debts you can’t eliminate through bankruptcy.

Debt Consolidation or Bankruptcy: Which Should I Choose?

Debt consolidation is a good option if you fell into debt for a specific reason such as a medical bill or if you simply lacked financial discipline. Consolidating your debts and making your payments on time can improve your credit score in a short period of time.

However, if you’re not prepared to change your spending habits, consolidating your debts may not help and can make your situation worse.

Alternatively, bankruptcy may be the option for you if you need to free yourself of your debts immediately. Whereas debt consolidation can take around five years to pay off, the bankruptcy process can be completed in nine months.

Take into consideration that bankruptcy does put a strain on your credit history for 5-7 years – but it can protect your valued assets such as your home and vehicle.

Deciding between the two can be a complicated endeavor, so it’s recommended that you speak with a credit counselor or a bankruptcy trustee to best explore your options.

This way, you can make the best choice for yourself, your family, and your financial situation.

Tips for Managing Debt

If you’re not quite ready to take the plunge into debt consolidation or bankruptcy, here are some tips for managing your debt:

  • Pay more than the minimum payment – the majority of your payment goes toward interest fees and not what you owe.
  • Pay off the debt with the highest interest rate.
  • Get a second job and pay off your debts aggressively.
  • Create a budget and track what you spend versus what you earn – look for areas in which you can save money (groceries, eating out, entertainment, etc.)
  • Always pay on time in order to maintain your credit score.

Take Control of Your Debts

With options such as debt consolidation and bankruptcy available to you, there’s no reason why you should spend your life stressing over and struggling with debt!

Yes, your credit score isn’t going to look pretty for a while, but these options will provide you with an opportunity to start fresh and keep a handle on your finances.

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