Debt Consolidation vs Bankruptcy in USA: Which is Better?

Debt Consolidation

Most of us must have seen advertising campaigns from credit consolidation companies and bankruptcy attorneys’ offices claiming to provide a solution to you existing financial problems especially debt.

Typically such advertisements promises to free you of any debt related worries by picking up their phone and calling them.

But, is their claim true? And if so, which is the better option – debt consolidation or bankruptcy?

Debt Consolidation vs Bankruptcy

Let’s look at a comparison of how credit consolidation works versus bankruptcy and how each can affects credit as well as your life.

What happens when you stop paying creditors?

When you are behind monthly installments or simply stop paying the lenders; the first thing that happens is getting phone calls from the companies you owe money to. At first these calls seem harmless and a representative will politely ask you to pay your balance as early as possible. And this behavior and process is perfectly fine. After all, it’s their money.

But as you continue defaulting the payments the situation worsens. Creditors will call several times a day making calls and threats to intimidate you for paying the debt. Your credit card interest rate will go through the roof, the credit card companies will report the delay to the credit reporting agencies like Equifax, Experian and Transunion. This in turn will worsen your credit history and hardly any other company will approve a credit application for you in the future.

Eventually you may receive a legal notice which you must answer to in court and sometimes even wage garnishment i.e. asking employer to withhold specific amount of your paycheck.

So you are unable to make the payments and started getting calls from creditors. And it doesn’t look like there will be a sudden change in your income that will help you to get out of debt.

So which is a better decision, to do a credit consolidation or a bankruptcy?

Let’s see what these options are and when to choose what.

How Debt Consolidation Works?

Debt consolidation companies basically create a new credit which is meant to pay off all the other debts incurred.

This has several advantages, sometimes the interest rate on this credit is lower than the interest rates on credit card debt. Additionally, it offers flexibility to make a single monthly payment instead of having to make multiple payments, depending on the number of creditors and the amount.

This new loan that will help to consolidate debt and make a single payment is a very attractive idea for many people facing financial difficulties. In addition to these advantages, the borrower feels more relaxed. Because if they meet the terms of their new creditor then they may be able to avoid bankruptcy and save their home from foreclosure. Ultimately the borrower gets a feeling of dodging a bullet.

But it is important to keep in mind that you must continue to be extremely cautious. And change the bad habits that led to a situation where you could not pay the debts. Even if you succeed in getting the debt consolidated, you still owe the money and it must be paid in full under the new terms.

How bankruptcy works?

The bankruptcy process in the United States is intended to protect consumers who have reached a level of debt that they are unable to pay. And therefore with the help of a bankruptcy attorney they file a petition in the court to determine if the debt can be forgiven.

There two main types of bankruptcy:

  1. The debtor cannot pay the debt and will value his or her belongings not protected under the bankruptcy legal code to pay his or her creditors.
  2. The debtor may still be responsible for paying some of the debt and the judge will set up a payment plan.

     

What are the advantages of bankruptcy over debt consolidation?

Government protects you during bankruptcy: Only bankruptcy can protect you from a lawsuit, garnishment of your wages, or emptying of bank accounts by the creditors. By filing a bankruptcy petition, an individual is automatically protected from credit bureaus, collection agencies, and lawsuits against them. The bankruptcy law has this type of “automatic stay” protection which makes collectors stop all collection efforts.

Private companies help you during debt consolidation: These programs are not government protection programs. But are programs of private companies that although they can help with the ease of debt payments do not have any legal backing to avoid a lawsuit or wage garnishment or calls from creditors to try to recover your money.

  • Debt consolidation can increase your tax payments at the end of the year while bankruptcy cannot.
  • Sometimes settlement companies will come to an agreement with your creditors to reduce the total amount of debt to be paid. When this happens you may have a large increase in the amount of taxes to pay in that year.

     

Surprising as it may seem, the tax laws state that if you settle with a creditor for less than the total amount you owe, the IRS will take into account the amount of money that was forgiven as additional income, and you are subject to additional taxes!

When a debt is forgiven by the bankruptcy process it is not treated as additional income and is not subject to tax.

Author Bio:

I am Nikesh Mehta, sole owner and writer of this site.

Nikesh Mehta - Image

I’m an analytics and digital marketing professional and also love writing on finance and technology industry during my spare time. I can be reached at [email protected] or LinkedIn profile.

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