Are you aware that millions of United States citizens are dealing with some form of debt, particularly when it comes to personal loans? These debts range widely from student loans to credit card balances. A recent study revealed that the average individual credit card debt is an astounding $8,000 per person, according to the Federal Reserve, and the total U.S. consumer debt reached approximately $4.3 trillion in 2023. Whether loans, education loans, or other types of debt, debt consolidation or bankruptcy could be a potential solution if you’re struggling to make payments.
If you have multiple loans and are unsure how you’ll pay off the total amount—and you know a good credit score is essential to qualify for future loans—then debt consolidation might be your best option. Debt consolidation can help restructure your existing loans and maintain a healthier credit score. However, before diving into how debt consolidation works, let’s clarify the difference between debt consolidation and bankruptcy. In this article, we’ll explore each concept in detail.
What is Debt Consolidation?
Debt consolidation combines multiple credit cards or loans into a single line of credit or loan. Is debt consolidation the same as bankruptcy? Unlike bankruptcy, debt consolidation helps you manage debt while keeping your credit score intact. While you’ll still owe the same amount, you’ll deal with fewer creditors and have just one payment to manage.
This can simplify loan management, helping you avoid late fees or missed payments. Missing payments can damage your credit score, so debt consolidation is particularly helpful if you’ve previously maintained a good credit history. In fact, a study by the American Bankers Association found that borrowers who consolidate their debt can reduce their late payment rates by as much as 33%. Debt consolidation saves you money on interest. However, this depends on your repayment term, the total loan amount, and any lender fees associated with new interest rates.
Here’s an example to best explain how debt consolidation works. Let’s say you have three credit cards with a total debt of $9,000, with balances of $2,000, $3,000, and $4,000, respectively. Each card has an APR (annual percentage rate) of 22%. Assuming your APR doesn’t change and you don’t add more charges, you’d need to pay around $280 monthly to pay off your credit card debt over nearly 4 years. By the end of this period, you would have paid $6,746 in interest in addition to the original $9,000 balance. Imagine you qualify for a debt consolidation loan with a 12% fixed interest rate and a four-year repayment term.
In this case, your monthly payment would be approximately $237, and your total interest would be around $2,400. That’s a savings of roughly $4,346 over the original credit card payments. With debt consolidation, you can consolidate other types of debt besides just credit cards. It can include medical bills, high-interest personal loans & more.
So, this is a basic example of how debt consolidation works.
What Are the Different Types of Debt Consolidation?
Here are a few common types of debt consolidation.
- 401(k) loan: Some 401(k) plans allow you to borrow up to $10,000 or 50% of your balance, whichever is greater. These loans skip credit checks but have short repayment terms, especially if you change jobs.
- Balance transfer credit card: Transfer balances from existing cards to a new one, up to the new card’s limit. If you qualify, you may get an introductory low or 0% APR, but balance transfer fees might apply.
- Debt consolidation loan: This personal loan combines multiple debts into one. You’ll typically repay it in fixed monthly installments with varying rates, terms, and potential collateral requirements.
- Home equity line of credit (HELOC): A HELOC is secured by your home, offering a revolving line of credit up to a set limit. You’ll pay back only what you use, plus interest, with fixed or variable rates.
- Home equity loan (HEL): A HEL is a lump-sum loan secured by your home equity. You repay it in installments with interest, but failing to repay could risk losing your home.
What is Bankruptcy?
Bankruptcy, on the contrary, is a legal process. Is debt consolidation bankruptcy? For those with multiple debts and good credit, debt consolidation may be a better option, as it offers a way to simplify and lower interest payments without the credit hit of bankruptcy. It brings debt relief to those who can no longer repay their loans. For example, if you’ve accumulated overwhelming debts and can’t keep up with payments, you might file for bankruptcy to get relief. According to the American Bankruptcy Institute, there were 406,000 bankruptcy filings in the United States in 2022, with Chapter 7 and Chapter 13 being the most common.
Bankruptcy works by eliminating eligible debts, where liquidation happens on certain assets to pay off the debts, or a new repayment plan is suggested based on your income and existing assets.
When bankruptcy is declared, it usually initiates with the debtor filing a petition at the bankruptcy court. You can do it by yourself or have a lawyer do it on your behalf. Usually, a better option is to hire an attorney who can offer you this option. A decent attorney holds the credibility and the right to represent you in bankruptcy court. They often get you the best possible deal on your loan, so you don’t have to worry about proceedings.
As soon as you file for bankruptcy, if there’s a creditor who is trying to collect on your debts, they will eventually cease their attempts. You will be in protection from threats of foreclosure or repossession. Although bankruptcy is beneficial, it’s usually considered a last resort. It’s one of the options you take when you’ve humongous amounts of debt & no possible way of returning it anytime soon.
So before you opt in for bankruptcy, here are a few things:
- Bankruptcy often involves attorney, credit counseling, administrative, and trustee fees. Some fees may be waived, but costs add up.
- Bankruptcy can clear many debts, like credit cards, but doesn’t usually affect child support, alimony, federal student loans, or taxes.
- Bankruptcy can drop your credit score significantly, especially if it’s high, and remains on reports for seven to 10 years. In fact, a study from the FICO research group indicates that consumers who file for bankruptcy see a 200-300 point drop in their credit score.
- Bankruptcy may be reduced but not, so you might still owe part of your original balance.
- Depending on the case type, certain bankruptcies can lead to losing assets, like your car or home.
What Are the Different Types of Bankruptcy?
There are mainly two types of bankruptcy:
- Chapter 7 bankruptcy (liquidation): Requires selling nonexempt assets, like investments or vacation homes, to pay debts. Qualifying depends on a means test, making it ideal for those with limited income and dischargeable debt.
- Chapter 13 bankruptcy (debt restructuring): Involves a repayment plan to pay back debts without selling assets. Suitable for those with a steady income and nonexempt assets who don’t qualify for Chapter 7.
- Chapter 9 bankruptcy: For financially distressed municipalities, allowing them to reorganize debts.
- Chapter 11 bankruptcy: Designed for businesses, helping partnerships and corporations restructure and pay debts.
- Chapter 12 bankruptcy: Provides family farmers and fishermen with a repayment plan tailored to their income.
When to Choose Debt Consolidation?
Debt consolidation is good when:
- You need assistance with multiple monthly payments and want to simplify the process.
- When you want to maintain a good credit score & qualify for a lower interest rate.
- When you have a reliable income and can easily make your new payments.
- When you qualify for a balance transfer card or loan with a reasonable interest rate.
When to Choose Bankruptcy?
You can choose bankruptcy when:
- When you have a large debt, you don’t have any other debt relief option – including loan modification, debt consolidation, debt settlement, or forbearance.
- When you have a lawyer who can take you through the process.
- When your credit score has already taken a serious hit due to the inability to pay off.
- When you qualify for a mean test and get most of your debts discharged.
- It’s the only best option when you’ve weighed the risks.
Concluding Thoughts
Choosing between debt consolidation and bankruptcy is more than a financial decision; it’s about setting yourself on a sustainable path. If you cannot decide between bankruptcy vs. debt relief, it requires a close look at your financial situation and future goals to determine the best path forward. Both options have pros and cons, entirely depending on your situation.
Think about your income, credit goals, and ability to manage repayments. According to a survey by the National Foundation for Credit Counseling, more than 50% of Americans reported feeling overwhelmed by debt, emphasizing the importance of making informed decisions. Whether you aim to restructure debt or seestart, making the right choice can be a step toward a healthier financial future.
Are you overburdened by loans, and you’re paying a high interest? Debt consolidation is the perfect option to decrease your interest rate and pay off your loan seamlessly. At Mountains Debt Relief, we care about you, and we have the perfect debt consolidation option just for you. Feel free to consult us on your debt consolidation option. The first consultation is FREE.