If you are in the increasingly common dilemma of: Debt consolidation vs bankruptcy, surely this article is for you. We will explain in detail what each case involves, what the consequences and advantages are and, above all, the necessary requirements.
This is one of the most frequently asked questions in our offices nowadays. At Ortiz & Ortiz we have a team of New York bankruptcy lawyers who have been serving the community for over 30 years. Our financial and bankruptcy attorneys are ready to assist you in this process, contact us and let us know your case!
Which is really better in 2022: Debt consolidation vs bankruptcy?
Debt is a reality and you are not alone in this. We all have debt. Credit card debt, mortgage debt, medical debt, vacation debt, the car we bought a few months ago, student loans, child support, taxes, among others. What to do? The first thing you should do if you have a lot of debt is to be honest with yourself. Read on and find out how.
There are debts that can be covered month to month with your salary from your job or with savings if you were cautious. However, there are other times when we are not able to pay our debts with our income or savings and it is generating discomfort, anguish, irritation and many other unwanted feelings. Is this happening to you?
Then, it is time to make decisions. I have debts…what are my options?
- Consolidate debts: a strategy whereby you reduce your interest rate and monthly bill payments by combining them into one payment.
- Filing for bankruptcy: you file a petition with the Bankruptcy Court under Chapter 11 of the U.S code stating that you are unable to pay your debts.
While there are more options, these are the most common. Debt consolidation vs bankruptcy? What is better for me? Before we discuss these two options in depth, let’s gather a little information about your personal debts.
Take stock of your financial situation:
- This is very important to do when you are or think you are in debt.
- Think about all the expenses you have made, review your credit cards, account statements, e-mail and postal mail, and all the means by which your creditors could be collecting a debt from you.
- Make a list of each expense, keeping track of the amount and when it is due.
- Also note the interest rate you will have to pay each month for each debt. Include it in the amount of the debt, since that money will still have to come out of your pocket at some point.
If you don’t know where to find out if you have debt, read our article on How to find out all my debts in the United States.
What is debt consolidation?
Debt consolidation is a strategy or, rather, a process of paying off multiple debts to multiple creditors or lenders with a single loan or credit card. The goal of debt consolidation is to consolidate all unpaid amounts into one, in other words, all payments into one. This also reduces the interest rate, which helps lower the total amount owed.
How to consolidate debt?
The most common way to consolidate debt is to apply for a debt consolidation loan. This can be to a bank, credit union or online lender.
To consolidate debt you should know that:
- There are fees associated with the loan. Ask about them before you sign.
- Your credit score could determine whether or not you get the consolidation loan. Keep in mind that your credit score must be above 650. Check here how to improve your credit score.
- It may happen that the interest rate is not much better than what you are currently paying on your credit cards.
Other financial products to consolidate debt
There are different ways to get a debt consolidation loan. It can be through a specialized debt consolidation agency, a bank, a credit union, credit cards, among other options. Here are a few methods.
1. Balance Transfer Card
- This option works very well for consolidating revolving debt.
- It involves transferring all of your personal credit card balances to a new card with a lower interest rate or with an initial period with no interest.
- If you want to avoid deferred interest you must repay your balance in full during the initial period.
- The initial period is usually 12 to 18 months.
2. Personal loan with collateral
- This type of loan is generally easier to obtain.
- It has the disadvantage that if you fall behind on payments you could put the collateral assets at risk.
- Secured means that the lender gives it to you in exchange for underlying collateral such as existing certificates of deposit or savings account balances.
- The beauty of a secured personal loan, i.e., with collateral, is that it has lower interest rates than an unsecured personal loan.
3. Home Equity Loan
- Your home equity is the difference between the value of your home and what you owe on your mortgage.
- You can access a home equity loan or part of a home equity loan to pay off your debts.
- The advantage of this type of loan is that you will be able to consolidate your debt and get a lower interest rate.
- However, be aware that there is a great deal of risk with this type of loan. If you fall behind in paying your bills, you could lose your home.
4. Home Equity Line of Credit or HELOC
- You may be able to borrow against a home equity line of credit.
- But it’s not like you’re borrowing a fixed amount on a check, you’re getting an open-ended revolving line of credit that you can access over a period of time.
- And HELOCs have an adjustable interest rate, which could work against you if rates are trending upward.
5. Personal Line of Credit
- You can apply for a personal line of credit from a credit union or other financial institution.
- To do so, you must have a good credit score.
- This financial method can be just as beneficial as a personal loan.
- Opting for this type of credit will depend on the total amount you owe on other loans and accounts, as you will need a personal line of credit large enough to cover them all.
Advantages of consolidating your debts
When considering debt consolidation vs bankruptcy, it is important to know the advantages of the first option.
1. The process protects your credit score
- Debt consolidation is not public knowledge.
- Depending on the method you use to consolidate your debts, it may very well be known to you and the bank or other financial institution you choose.
- While the debt consolidation process will appear on your credit report, it does not lower your score as much as a bankruptcy filing might.
2. Maintain access to credit
- Unless prohibited by the debt consolidation agreement, you may be able to keep your credit cards. In the event of an emergency, it may be useful to have them.
- In the event that you owe a significant amount of money, you may not be able to use your cards, nor will you be able to access additional credit.
3. Reduce your total monthly payments
- Debt consolidation is going to simplify the management of your delinquent accounts.
- You will no longer have to keep up with multiple payments that also have different interest rates and different creditors.
- With debt consolidation, you will only have to make a single monthly payment.
4. You can reduce the total interest paid
- You will no longer have many interest rates to worry about. Now it will be just one, and probably lower.
Disadvantages of consolidating your debts
Although we have already seen some advantages of consolidating debts, there are also some disadvantages. Therefore, it is not a decision that should be taken lightly. Let’s review, below, some of the cons:
1. Possibility of losing a property or other asset.
- If you left your home or a vehicle as collateral for debt consolidation, you should know that you could lose those assets if you default on your loan payments.
- If you opt for debt consolidation, be aware of asset protection.
2. Hidden Costs
- Debt consolidation (vs bankruptcy) often becomes a very attractive option because the monthly payments are lower and so is the interest rate. However, beware of hidden charges.
- Hidden charges can make the debt end up costing more money in the end.
- Get out your calculator and do the math. If you stay in debt longer you could be paying more in the long run.
3. Negative tax consequences
- It’s going to depend on your financial situation, but any money you save from debt relief services as a result of debt consolidation could be considered income by the IRS. And, therefore, you may have to pay taxes on it.
- There are some credit card companies and other creditors that may report the settled debt to the IRS.
Note: If you have debts and are still wondering what to do about your financial situation, read our related articles and get out of all kinds of doubts. Can I go to jail for debt, What happens if I am sued for debt and can’t pay, What happens if I don’t pay a promissory note, and If a person dies who pays their debts.
Filing for bankruptcy
What does it mean to declare bankruptcy?
Filing for bankruptcy means that you have reviewed your financial situation and your debts are unsustainable. That is, you have no way to pay, even with reduced monthly payments or at a lower interest rate than what you currently have. This is when bankruptcy becomes a viable option.
You should know that there are six types of bankruptces, but two of them are most commonly used for personal bankruptcy: Chapter 7 and Chapter 13. Read on, as we will detail each of them below.
Main Types of Bankruptcy
As mentioned above, there are two main types of personal bankruptcy.
- Chapter 7 or also called “liquidation” bankruptcy.
- This refers to the fact that you will declare all the assets and property you have and these will be liquidated in order to pay off your debts.
- The sale of these assets will pay off lenders and creditors.
- Be careful, there are some assets that will be exempt from liquidation. These are some more personal items such as clothing, retirement savings, household goods, among others.
- The Chapter 7 bankruptcy process can take three to six months. This is from the time the forms are filed until the discharge of the debt.
- Once the bankruptcy process is complete, you will be back to square one financially.
- Chapter 13 bankruptcy is also called a “reorganization” or “wage earner plan”.
- That is exactly what happens, all of your debts are reorganized into a repayment plan to creditors for 3 or 5 years.
- Through this plan you can pay all or part of your debts.
- The repayment plan is proposed by you, but ultimately the bankruptcy court will decide the duration of the plan. Note that the plan is based on court-mandated budgets that also follow IRS guidelines.
Note: Read more about filing for bankruptcy Chapter 7 and filing for bankruptcy Chapter 13. Also, check here for the main differences between Chapter 7 vs 13. And if you want to know more about bankruptcy possibilities, also read about What is Chapter 11 bankruptcy.
Bankruptcy Filing Process
- Credit Counseling: If you are seriously considering bankruptcy, you should be aware that you must take a credit counseling course within six months before filing for bankruptcy.
- Bankruptcy Means Test: Your current financial situation will be analyzed and your chances of being able to repay your debts assessed.
- Gathering paperwork and documents: Whether you ultimately qualify to file for bankruptcy will depend on this step.
- Bankruptcy petition and forms: This step should be done in consultation with legal counsel.
- Automatic stay: Once you file for bankruptcy with the Bankruptcy Court, all of your debts will be automatically stayed. This means that creditors and lenders will not be able to pursue you for collection.
- Debt Trustee: In this process, the court will take control of your debts through a court appointed trustee.
- 341 Meeting of creditors
- Plan Confirmation if you filed for Chapter 11 or 13.
Learn more about the process of filing bankruptcy in our article How to File Bankruptcy in New York.
Advantages of filing for bankruptcy
1. Fresh financial start.
- You will eliminate all dischargeable debts.
- There will be no more outstanding payments and no more creditors calling you.
2. Automatic stay
- By filing bankruptcy you will be able to stop collections, foreclosures and garnishments.
- Thanks to the automatic stay of collections, there will be no more insistent calls from creditors or lenders.
3. Relatively fast process
- You can do it in a few months.
- Reduces the total balance or part of the debt.
- Shortens the amortization period.
- The automatic stay stops creditor collections, foreclosures and garnishments.
Disadvantages of filing for bankruptcy
- Filing for bankruptcy will negatively impact your credit. This can be a problem after bankruptcy because you will be starting from scratch and may have some difficulty applying for financing.
- You will need to qualify through the means test after a thorough analysis of your financial situation.
- Any assets you have that are non-exempt may be liquidated.
- It may appear on your credit report for up to 7 years after filing.
- Bankruptcy will negatively impact your credit score. You may find yourself in a difficult situation when you want to get credit for something again.
- It will take at least three years and in that period you will not be able to have credit without a court permission.
- Privacy and reputation. Bankruptcy records are public domain. In addition, the bankruptcy will continue to appear on your credit report for up to 10 years after filing.
debt consolidation vs bankruptcy, Which is right for you?
Both debt consolidation and filing for bankruptcy are paths that will alleviate your financial situation. Debt can be very difficult to deal with and even more so if you have creditors or lenders chasing you.
We have already discussed what each of these ways out of debt are and what the advantages and disadvantages are. Now let’s look at when to opt for each in the dilemma of debt consolidation vs bankruptcy. Read on!
When is it convenient to consolidate debt?
We said it a few lines earlier. Debt consolidation allows you to pool all your debts and transform them into a single debt, with one interest rate. This way you don’t have to worry about the maturity date of each one. In addition, it will buy you time in case you are getting overwhelmed because you can’t make each payment each month.
Who opts for debt consolidation:
- Consumers who have multiple debts and with a variety of credit cards. They do debt consolidation because they can reduce interest and consolidate all debts into one loan.
- Debtors who have good credit. In the end, if you are in debt but still have good credit, you can easily opt for debt consolidation and reduce your current interest rates.
- Debtors who have a good credit history. Those who have been punctual in their payments and who have a high credit score, and who have now been overwhelmed by debt, also opt for debt consolidation.
When is it best to file for bankruptcy?
Chapter 7 and Chapter 13 bankruptcy are very different and target different consumers. Let’s review separately when it is best to file for each chapter.
When to file for Chapter 7 bankruptcy:
- If you pass the means test. That is, you prove that you don’t have the ability to pay your debts.
- Those who have no assets to protect.
- People who are already far behind on their credit don’t have much to lose by filing bankruptcy. Their credit score has probably already declined.
When to file for Chapter 13 bankruptcy:
- Those who have the financial solvency to repay their debts over a 3-5 year plan.
- If you have a lot of assets that you would like to protect, Chapter 13 is a good alternative.
- Those who do not qualify for Chapter 7.
Why hire the attorneys at Ortiz & Ortiz?
If you are reading this article and you have come this far, it is because you are in a dilemma: Debt consolidation vs bankruptcy. Which is better option for your case?. Maybe you are in debt, but you don’t know to what level and you need help. In that line, you don’t know how to move forward and you don’t know whether to consolidate your debt or file for bankruptcy.
Having debts and creditors collecting every day can be a huge headache. But, don’t worry. Our estate planning attorney in New York can review your case and analyze your options:
- They will be able to help you analyze your financial situation and see how serious it is.
- They will be able to advise and guide you through this process so that you can make the best decision for your financial situation.
- In addition, whatever decision you make, they will be able to accompany you in this process.
For these and other services contact us today.