Bankruptcy vs. Credit Counseling: Which Is Best for You?
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Job loss, medical emergencies, or even divorce could turn a sound financial base into trouble, forcing you to make tough decisions with several long-lasting consequences. We saw a surge in bankruptcy filings during the Great Recession, but they have declined. However, the current economic situation has put a lot of people in financial trouble. If you are one of those, keep reading.
When you cannot pay your bills, you have two choices – credit counseling services and bankruptcy.
Credit counseling can allow you to create a plan with the help of an expert, and it is an ideal alternative when your financial condition is in trouble. When you work with a nonprofit credit counselor, you can create a debt management plan to restore your financial stability without filing for bankruptcy.
Another option is bankruptcy. Those who file for bankruptcy should go through credit counseling as per law. However, financial counseling can lead to a solution that does not require bankruptcy. It is a debt remedy and helps learn budgeting skills while creating a debt management plan that helps resolve financial problems. Before choosing between the two, understand the pros and cons and move wisely.
A lot of us run into financial trouble and never see it coming. It could be a big medical bill, student loan, or several unpaid balances on your credit cards. Irrespective of how trouble hits you, you will face default if you cannot handle expenses and pay bills.
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Do-it-yourself debt management
To regain control of your finances, you will have to try to resolve the debt issues yourself. Start by contacting the creditors and explaining your situation. Now, see if they are willing to work out a payment plan and give you enough time to rework your budget. You could also look for a second job and commit to repaying the debt. Once your creditors know that you really want to pay the debts but might have to opt for bankruptcy, they will be motivated to work with you. Do-it-yourself debt management is possible, but it will need a lot of time, negotiation skills, and a disciplined approach to budgeting.
What is credit counseling?
Credit counseling is one solution when you are in financial trouble. When you opt for credit counseling, you will work with a nonprofit credit counselor who will review your financial statements and consider your income to help you decide if you are suitable for a debt management program.
Most people who opt for nonprofit credit counseling agencies often find out that a plan will work for them only and only if they commit a few years to pay off the creditors. Make sure you use a nonprofit organization since many debt settlement companies are known for advertising but charge heavy fees and do not solve your problem.
Through a debt management plan, you can reduce the monthly payments by reducing the interest rate on the credit card. If the income is not enough to resolve your debts in about 3-5 years, then the counselor could advise bankruptcy. You might also be asked to close all the credit card debt accounts.
In case of unsecured debts, you need to be very careful about the solution you use for payments. Many people take out a second mortgage or use an equity line of credit on the home to pay off debts. Do not use your home as collateral because you could lose your property if you cannot make the payments on it. A credit counselor will explain each option in detail and give advice. You can then choose the right plan for your situation.
Besides these two options, there are other debt-relief options too. If these options are unsuitable for your financial situation, you might want to consider debt settlement or credit card consolidation.
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Pros and cons of credit counseling
Pros
- Avoid the negative consequences of bankruptcy.
- It is free, so you can get advice without spending anything.
- You will have a debt management plan to consolidate your bills into one payment at lower interest rates.
- Helps rebuild your credit if it has dropped due to borrowing.
- Helps you learn to create budgets and stick to them.
Cons
- You might not follow through, and the debt management plan will only succeed if you stick with them.
- No debt forgiveness.
- Debt managers and credit counselors can help, but it might not work.
- You will need to pay exactly what you owe, so if you default on a payment, the concessions you received will be eliminated.
- Another financial setback could jeopardize your willingness to follow the plan.
What is bankruptcy?
Bankruptcy is your last resort. If the debts are too high and you cannot even manage the minimum payment and cannot follow through on a debt management plan, your only option will be bankruptcy.
Despite the negative stigma associated with it and its pitfalls, it is sometimes the best solution when you cannot meet the debt repayment plan. It will take time to reach a bankruptcy settlement since it usually begins with a pre-file credit counseling session where your income, assets, and liabilities will be assessed. Look for certified counselors at the National Foundation for Credit Counseling.
It will then move to a federal bankruptcy court, and the case will be adjudicated. Certain states could let you keep some assets while asking you to sell the other possessions. In this case, your creditors will have to accept less than the amount you owe. Your credit score will take a huge hit the moment you file. The counseling will help decide which type of bankruptcy petition to file.
You can file for bankruptcy under Chapter 7 or Chapter 13 of the bankruptcy code. Under Chapter 7, all non-exempt assets will be liquidated and distributed to creditors. Exempt items include your household furnishings, cars, and work-related tools.
The bankruptcy will remain on your credit report for over 10 years, making it hard to borrow money. However, under Chapter 13 bankruptcy, you can keep some assets like your home or a car, but you will have to repay the other debts.
Through this, you will discharge some unsecured debts like consumer debt and those tied to credit card accounts. Chapter 13 bankruptcy will remain on your credit report for seven years.
Once you file for bankruptcy, you will have to take another bankruptcy credit counseling session known as a debtor education course which covers money management, budgeting, and the wise use of credit. It takes about two hours, and the counselor will weigh all your options and provide details about handling the aftermath after the case settlement.
Pros and cons of bankruptcy
Pros
- Does not need creditor approval since the judge will decide the amount your creditors will get based on your assets.
- You can eliminate the debt strain, and collection agencies will no longer contact you.
- Chapter 7 will clear away unsecured debt, including medical bills, credit card balances, student loans, or personal loans.
- You can rebuild credit once the case is resolved.
Cons
- Long-lasting consequences could even take a decade for it to drop from the credit report.
- If you manage to get a loan, it will carry a very high interest rate.
- Potential employers will know about your bankruptcy and may not be willing to hire you.
- It could also become hard to rent a house or apartment.
- Discharges can be revoked.
FAQs
Are credit consolidation and bankruptcy the same?
Credit consolidation and bankruptcy are common debt relief options, but they are not the same. Bankruptcy is a legal process that will relieve you of the debt obligations, while debt consolidation involves taking out a new loan to consolidate all the outstanding loans into one single monthly payment with a low-interest rate.
Is insolvency better than bankruptcy?
Although insolvency and bankruptcy may sound the same, they are not. Bankruptcy is a legal process and declaration, while insolvency is a financial situation. When you are insolvent, you may have other alternatives to consider before you file for bankruptcy.
Are there any benefits of credit counseling?
There are several advantages of credit counseling, including low-interest rates as well as forgiveness. But do not expect that your accrued interest will be forgiven. In case you cannot follow the debt repayment plan, your lenders could claim the entire debt balance. The biggest benefit of this option is that you have a repayment plan based on your financial situation and the ability to make payments to go debt-free eventually.
Start with a custom credit evaluation (free for a limited time)
- Expert evaluation of your credit
- Your score
- Recommendations tailored for you
- Summary sent to you -- yours to keep!
The bottom line
When it comes to choosing between a debt management plan vs. bankruptcy, it will depend on your situation, the amount as well as your ability to make repayments. When you undergo counseling and create a debt management program, you will see a higher credit score close to 2 or 3 years after the beginning of the plan.
Even if you file for bankruptcy, it is necessary to pre-bankruptcy credit counseling. Hence, no matter what alternative you choose, you will spend time with a credit counselor. No matter what your financial goals are, it is essential to work with a reputable counselor. You can find a list of counselors from the Federal bankruptcy court.
The objective behind credit counseling and bankruptcy is the same: to help you get on the road to financial stability. Speaking with a certified credit counselor can help you make the right choice and overcome money problems. Both options have their pros and cons, but if you can follow a debt management plan and are ready to stick to it for the next four to five years, credit counseling can be an ideal alternative. But bankruptcy could work better if your debts are very high or you are in a rush to get past them.
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Writer
Vandita Jadeja is a financial writer and editorial assistant at Joywallet. She loves to read and write about money and brings 7 years of experience from the financial industry. She loves coffee, mountains and sunsets.
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