Key Takeaways

Debt consolidation and bankruptcy can both be valid options for relief, depending on your financial situation. Debt consolidation involves taking out a line of credit or loan to repay your debts under more favorable terms. Bankruptcy can reduce or wipe out your debts, but it also damages your credit for years.

If you’re overwhelmed with debts and weighing your financial options, it’s crucial to understand the differences between debt consolidation vs. bankruptcy, how they work, and their pros and cons to craft an effective debt management strategy.

Definition of Debt Consolidation

Debt consolidation is a process through which you can roll multiple debts into a single new line of credit or loan. Debt consolidation loans are usually unsecured personal loans. The new debt you take out should ideally be at a low-interest rate so you can lower your cost of repayment.

Definition of Bankruptcy

Bankruptcy is a legal procedure that protects businesses and people with crippling debt. It can discharge or eliminate many types of debts, such as utility bills, rent, and credit card debt. However, bankruptcy can’t eliminate child support, alimony, and unpaid taxes. Chapter 7 and Chapter 13 are two main types of bankruptcy for individuals.

Pros and Cons of Debt Consolidation Vs. Bankruptcy

When comparing debt consolidation vs. bankruptcy for debt relief, it’s important to consider the pros and cons of each option so you can determine which one will be the most suitable for your financial situation.

Pros of Debt Consolidation

  • It allows you to combine multiple debts into a single monthly payment.
  • You may be able to save a considerable amount of money in interest if you qualify for low-interest rates.
  • Monthly payments should be lower, so it will be easier to keep up with debt payments.
  • Debt consolidation won’t impact your credit as drastically as bankruptcy. If you make timely payments, it may even help you improve your credit score in the long term.

Cons of Debt Consolidation

  • You’ll need a high credit score to qualify for a low-interest rate.
  • If you don’t qualify for a low-interest rate or extend the repayment period, you may end up paying more.
  • It may take years to pay off debt and will require you to be consistent and disciplined.

Pros of Bankruptcy

  • Bankruptcy can wipe out most types of unsecured debt, such as medical bills, credit card balances, and personal loans.
  • You’ll get a fresh start after your debts are wiped out and can start rebuilding your credit.
  • Bankruptcy can halt wage garnishments, repossessions, foreclosures, and other collection efforts.

Cons of Bankruptcy

  • Bankruptcy is a part of public records, so employers or anyone else can learn about your bankruptcy.
  • You may need to give up nonessential and luxury property and possessions.
  • It may be difficult to qualify for bankruptcy and pass the means test.
  • Bankruptcy does not eliminate child support, student loans, tax debt, and alimony.
  • If you opt for Chapter 13 bankruptcy, you’ll have to stick to a payment plan to repay some of your debts. You’ll need to fulfill the repayment terms for the court to discharge your debts. 
  • The bankruptcy process can be expensive, depending on the complexity of your case.

Impact on Credit Score and Credit Report

Every debt relief option you choose will have some impact on your credit score. It’s important to consider the short-term and long-term impact of debt consolidation vs. bankruptcy on your credit report and understand what they may mean for your financial future.

Debt Consolidation and Credit Score

Debt consolidation may have both a negative and positive impact on your credit. When you use a loan to pay off large credit card debts, it reduces your credit utilization, which can improve your credit score.

On the other side, when you use a balance transfer card to consolidate credit cards, it may again lead to high credit utilization on your new card. But credit scores can also quickly change as you continue to lower your credit utilization. If you are confident that you’ll be able to quickly pay off the balance on the new card, the temporary dip in the credit score may be a worthwhile risk to gain savings in interest.  

Bankruptcy and Credit Score

Bankruptcy can hurt your credit severely. Chapter 7 bankruptcy remains on your credit report for ten years, while Chapter 13 remains on your credit report for seven years. The effect will be most profound in the first few years after you file for bankruptcy.

The impact of bankruptcy will lessen over time, but many lenders may refuse to offer credit to you until your credit report improves. It’s important to note that when you file for bankruptcy, it may be at a point when your credit is already lower due to repossessions, foreclosures, accounts in collections, and missed payments. In such cases, the additional hit to your credit may not matter as much.  

Cost and Fees

Debt consolidation and bankruptcy both involve a cost. When you are already dealing with a lot of debt, it’s crucial to take a closer look at the fees you may have to pay so you don’t end up in a worse position.

Costs and Fees of Debt Consolidation

The interest rate you’ll be able to get on a debt consolidation loan will depend on your credit history, your debt-to-income ratio, and other factors. The higher your credit score, the lower your interest rate will be.

Personal loan APRs can range from 4% to 36%. The average personal loan interest rate is 14.47% in 2023. Credit unions may offer lower rates than banks. If you opt for a 0% balance transfer credit card, the average introductory period is 13 months, after which you’ll need to pay the regular APR.

Another important point to note is that with balance transfer credit cards, you’ll need to pay a 3%-5% fee for transferring the balance.

Costs and Fees of Bankruptcy

When you file for bankruptcy, you’ll need to pay a petition fee of $313 for Chapter 13 and $338 for Chapter 7 bankruptcy. Another requirement is that you’ll need to attend credit counseling sessions as a requirement for filing bankruptcy. Credit counseling sessions can cost anywhere from $10 to $50.

Another major cost that you should expect is the fee you’ll pay your attorney. Fees can range from $750 to $4,500, although attorney fees tend to be higher for Chapter 7.  

Determining Which Option is Right for You

When trying to choose between filing bankruptcy vs. debt consolidation, take into consideration several factors, such as:

  • Your credit score
  • Your income predictability
  • Your overall financial health
  • The amount of debt you have

Considerations for Debt Consolidation

Debt consolidation may be a better choice, but it’s not for everyone. It’s usually a good choice when:

  • You have the ability to pay off the debt. When you take out a debt consolidation loan, you’ll get more favorable terms, but you’ll still need to pay it back.  
  • You are disciplined enough to stick to the debt consolidation program. You’ll need to make timely payments each month for the duration of the loan to be debt-free.
  • You have a good credit rating. The higher your credit score, the lower the interest rate you’ll be able to get. This will give you the opportunity to save a considerable amount in interest charges.
  • You have multiple credit cards or unsecured loans. Debt consolidation rolls multiple debts into a single loan to simplify payments and reduce interest.

Considerations for Bankruptcy

Filing for bankruptcy is a major life decision and one that you shouldn’t take lightly. Bankruptcy is usually the last resort option when you don’t have the means to get out of debt and can’t qualify for debt consolidation. It may be best for you if:

  • You can pass the means test for Chapter 7 bankruptcy. You won’t qualify if your income is too high.
  • You don’t have assets. If you have multiple vehicles or second homes, you won’t be able to protect them from liquidation when you file for bankruptcy.
  • You already have bad credit. If you are behind in paying bills, have defaulted, and your credit scores are already low, the impact of bankruptcy won’t matter as much.  
  • You have a lot of dischargeable debts. If you have tax debts or are behind on alimony or child support, you won’t be able to discharge them through bankruptcy.
  • You can afford to make payments for three to five years. If you are filing for Chapter 13 bankruptcy, you must stick to the proposed repayment plan.  
  • Your combined unsecured and secured debts are less than $2,750,000. You can file for Chapter 13 if the total amount of your debt doesn’t exceed this limit.

How to Choose the Right Debt Consolidation or Bankruptcy Company

Once you’ve determined the right option from debt consolidation vs. bankruptcy, the next step is to determine whether you want to do it yourself or hire a company. Hiring a debt relief company can help ensure that you receive reliable advice and the support you need. If you’re filing for bankruptcy, it’s best to work with a bankruptcy attorney.

Here are a few important considerations when choosing a company to work with:

  • Check to see if there are any complaints registered against the company with the Consumer Financial Protection Bureau (CFPB).
  • Contact the attorney general in your state to see if any action is taken against the company you want to work with.
  • Check the profile of the company on Better Business Bureau. The company should have a good rating on the website.
  • Ensure the company has a good track record of helping clients. Check the reviews on reliable third-party review sites like Trustpilot.
  • Ask questions about their services and process.
  • Make sure the company has a good turnaround time when it comes to answering customer queries and addressing concerns.
  • Ensure they do not ask for any upfront fees. Debt relief companies cannot charge you any fees until they deliver the service.

The Bottom Line on Debt Consolidation Vs. Bankruptcy

If you are feeling overwhelmed with mounting debt, debt consolidation can help ease the pressure and save you money in interest charges. But for borrowers with low credit scores that make it difficult for them to get new credit, bankruptcy may be the right choice. Bankruptcy may be a tough choice compared to other debt relief options, but it should be seen as a financial tool that may be necessary. It can help you wipe off your debt and start with a clean slate.

There are several other debt-relief options available if neither of these options seems right for you. Contact TurboDebt for a free consultation to see what debt relief option may best suit you. Our team will offer you a personalized debt relief option based on your individual needs.