Debt Consolidation vs. Bankruptcy: Which Is Right for You?

 March 3, 2020
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Considering debt consolidation versus bankruptcy might feel like picking between a rotten apple and a spoiled banana. Either one is going to turn your stomach.

But making the right choice between these two options could set you on a path to feeling much better about your finances. Here’s what you need to know about the basics of debt consolidation and bankruptcy.

Debt consolidation vs. bankruptcy: The basics
Major pros and cons of debt consolidation
Major pros and cons of filing for bankruptcy
Debt consolidation vs. bankruptcy: Which is better for you?

Debt consolidation vs. bankruptcy: The basics

Debt consolidation refers to taking on new debt to cover your old debt.

You could borrow an unsecured personal loan, for example, to pay off what you owe to creditors. A home equity line of credit or a balance transfer credit card are other strategies for the same end goal.

It might seem counterintuitive to take out different debt when you already feel like you’re drowning. But taking out the right personal loan could get you a lower interest rate and simplify your repayment.

Bankruptcy has its own set of rewards and consequences. You could discharge some or all of your debt via Chapter 7 bankruptcy, or repay some or all of your debt with a new repayment plan via Chapter 13 bankruptcy.

With either proceeding, however, you’ll harm your credit report for years to come.

Major pros and cons of debt consolidation

Debt relief companies or debt consolidation programs offer debt consolidation as a service, but for a price. You could consolidate your debt on your own, however, without opening your wallet.

Instead of paying for professional advice, rely on a certified credit counselor working for a nonprofit organization. You can find a list of legitimate credit counseling agencies via the Department of Justice.

Before you pursue debt consolidation, check out the following pros and cons.

Pro Con
Get a single monthly payment You’ll need good credit or a cosigner
Reduce your interest rate Your debt won’t be discharged
Put an expiration date on your debt

Pro: Make one payment to one lender

If you’ve fallen behind with multiple creditors, you might love the idea of making one payment to one lender.

For example, you could borrow a personal loan, use the funds to pay off all your creditors, and then focus 100% of your energy on paying off the new loan.

Con: You need to have solid credit (or a solid cosigner)

The catch to debt consolidation is that you’ll need at least solid credit to qualify for a loan, and even better credit to get the lowest possible interest rates.

The reality is that if your finances are a mess, your credit score might be too.

Still, there are ways to consolidate your debt with bad credit. You could find a cosigner and piggyback on their strong credit report, for example.

Pro: You could score a lower interest rate

Say you have credit card debt with an APR of 15.00%. With a personal loan, you could find an even lower rate if you qualify, or have a cosigner who does. These vetted personal loan lenders, for example, offer rates starting well below 10.00%.

That said, be on the lookout for origination fees from personal loan companies. When shopping around, compare APRs because they include both the interest rate and the origination fee, if there is one.

Con: You may continue a cycle of debt

Although an unsecured personal loan could wipe out some or all of your existing debt, you’ll still be responsible for paying off new debt.

To break the cycle of debt, it’s wise to stop borrowing money as soon as you’ve consolidated your debt. Start by cutting up your credit cards and re-evaluating your spending patterns.

Pro: You can set an end date for your debt

Credit card debt has no predetermined finish line. You can be making monthly payments to your card issuers and feel like your repayment is stretching on forever.

Through debt consolidation, you work with your lender to choose a fixed repayment term. Many personal loan companies offer a range of repayment terms that are five years or less.

You could also find lenders offering longer repayment terms to lower your monthly payment amount. Be aware that the longer your term, the more interest you’ll pay over time.

Major pros and cons of filing for bankruptcy

You need to have a minimum amount of income to prove your inability to repay your debt when you file for Chapter 7 bankruptcy.

You surrender nonexempt assets to pay off secured debt. You might even have to yield other property to pay off unsecured debt.

You could assess your eligibility for both Chapter 7 and 13 bankruptcy proceedings by working with a credit counselor to review your options. Consider these pros and cons before you go that route.

Pro Con
Discharge debt or make repayment more affordable You might forfeit property, assets
Restart your financial life You could be on the hook for lawyer, court fees
You won’t receive a clean slate

Con: You could lose your property and assets

With a Chapter 7 bankruptcy, any asset that can be turned into cash will be used to pay off your debt. Only exempt assets, which are determined by your state’s laws, would be protected from being sold.

If you prefer holding onto your assets, such as saving your home from foreclosure, you might elect for a Chapter 13 bankruptcy. But you’d want to consult a credit counselor or bankruptcy lawyer to review your options.

Pro: You can hit the reset button on your repayment

With a Chapter 7 bankruptcy, you could dispose of some or all of your debt.

With a Chapter 13 proceeding, you would establish a three- to five-year repayment plan for your remaining debt. That repayment plan might even give you the convenience of a single monthly payment if you’re working with a credit counselor on a debt management plan.

Con: You’ll need to prepare for lawyer and court fees

Even if you discharge some or all of your debt via bankruptcy, the proceeding itself can keep you in the hole.

Aside from footing the bill for a bankruptcy lawyer, there are a variety of court fees to handle. You could expect to shell out between $1,500 and $4,000 on average, according to

Pro: You can rebuild your credit (eventually)

Bankruptcy will harm your borrowing reputation in the short term, but you’ll be able to rebuild your credit in the long run.

With your bankruptcy behind you, you could start by monitoring your credit report and taking small steps such as becoming an authorized user on a significant other’s credit card.

Con: It might not be the fresh start you imagined

Whether you’re considering Chapter 7 or Chapter 13 bankruptcy, it won’t offer you the clean slate you might have been expecting.

For one, it’s unlikely you’ll discharge every cent of your debt. Student loans are difficult to discharge via bankruptcy, for example.

Even if you’re in the minority of consumers who could exit a proceeding debt-free, you’ll be left with little to no assets and a credit report in need of serious repair.

Consider that if you tried to borrow a federal Parent PLUS student loan, for example, the Department of Education would deem you to have adverse credit history if your bankruptcy occurred within five years. Private lenders would also be skeptical of a credit report showing a recent bankruptcy.

Debt consolidation vs. bankruptcy: Which is better for you?

Debt consolidation is generally preferable to bankruptcy because it puts you in the driver’s seat. With a debt consolidation loan, for example, you simplify your repayment. You also begin working toward a date of being debt-free.

But debt consolidation isn’t for everyone.

“Taking a loan to consolidate debt can make sense when an individual is optimistic that their financial situation will be improving,” said debt relief lawyer Simon Goldenberg. “However, if [they’re] in serious financial turmoil, a consolidation loan is likely just a temporary patch, as the borrower may struggle to keep up with the payments.”

Ultimately, Goldenberg said, a borrower might just be “kicking the can down the road” with debt consolidation if they can’t come up with a long-term solution for handling debt repayment.

If your debt is beyond the point of being helped by consolidation, you might consider bankruptcy. It’s the closest thing to getting a redo in your financial life. The court case might even allow you to discharge a chunk or all of your debt.

Rebuilding your savings and credit will take time after filing for bankruptcy. But student loan lawyer Stanley Tate said some of his clients have added 100 points to their credit score within 18 months of bankruptcy.

“Whether to file bankruptcy is a pure math question,” Tate said. “If [the math makes sense], you can get rid of thousands of dollars in debt quicker and cheaper than you could if you consolidated.”

Seek professional advice from a credit counselor or bankruptcy lawyer to make the best decision for you. Don’t get talked into something that isn’t in your best interest.

If you’re still on the fence about debt consolidation versus bankruptcy, consider creating a debt management plan as an alternative strategy.

For a fee, a debt relief company can provide extra support to people overwhelmed by debt. This service often includes negotiating with creditors on your behalf to lower monthly payments, rates and what you owe. It can also restructure your debts into a single monthly payment plan. Many debt relief companies will also provide counseling to help you create a budget that works.