If you get in over your head, financially speaking, it can be nearly impossible to get out without some help. Debt consolidation, the name for programs that combine your debts to make them easier to repay, can offer you a chance to get back on your feet without going through a long court process. Bankruptcy, which does require a court process, can erase some of your debts if you successfully complete your case.
Debt consolidation plans, also called debt settlement, typically offer to combine all of your debts into one loan that you must pay back over time. Consolidation companies may also try to negotiate with your creditors to reduce your current debts. Some debt consolidation programs essentially trade one loan for another. For example, you can take out a home equity loan, or other loan using your home or property as collateral, and use that money to pay off your debts. Some debt consolidation plans require you to deposit your payments into a separate account for several months, letting the company administering your plan negotiate and pay your creditors using that money.
While debt consolidation can work for some debtors, it can also cause additional problems. For example, you must be behind in your payments before debt settlement companies can negotiate settlements for you. Thus, your credit rating may suffer because you are behind. Additionally, creditors may refuse to negotiate with your debt consolidator, so your overall debt load may not decrease. If your debts are forgiven, you must pay taxes on the forgiven amount because it is considered income. If your consolidation plan involves getting another loan and using that money to pay your debts, you are still responsible for making payments on the new loan, so if you could not make your payments before, you may not be any further ahead than you were before.
Chapter 13 bankruptcy requires you to submit a three- to five-year repayment plan that puts your entire disposable income toward debt repayment. If you choose to file for bankruptcy, you must complete credit counseling before filing and keep up with your court-approved payment plan. Once your plan is approved, you make payments to a court-appointed bankruptcy trustee who then pays your creditors. The entire process is supervised and administered by the trustee, though you may choose to hire an attorney to represent you.
Pros and Cons
Bankruptcy allows you to restructure your debts, even past-due mortgage payments so you can keep your home. Another benefit of filing bankruptcy is the discharge, or erasure, of debt that comes after you successfully complete your repayment plan. Many types of debt, including credit card debt, can be eliminated by court orders once your plan period is complete—an option that isn’t available with debt consolidation. Bankruptcy also offers an automatic stay once you file your case, stopping all collection actions against you. Such a stay is not available with a non-bankruptcy debt consolidation program. However, like debt consolidation, bankruptcy is a negative mark on your credit report and may prevent you from getting a loan until several years have passed.