The Bankruptcy Vs Debt Consolidation Decision

Bankruptcy vs debt consolidation is an important decision for those with unpaid credit card debt, small loans and other unsecured forms of debt. They are a way of reducing your income-to-debt ratio and/or making repayments more affordable. Whilst clearing that first hurdle can appear difficult, they offer the first step towards a debt-free lifestyle.

Is Bankruptcy vs Debt Consolidation Better for Improving Affordability?

Filing for chapter 7 bankruptcy will help you to write-off most forms of unsecured debt without making any repayments to creditors. You will enjoy full court protection from creditors and collection agencies. It is possible to become debt-free in just 4 to 6 months.

Debt settlement negotiation will enable you to clear up to 50% of unsecured debt, but it will be necessary to make repayments to creditors on the remainder for a period of 12 to 36 months. There is also a management charge of 15% of total monthly contributions. Whilst creditor contact is less likely, no court protection is provided.

Neither debt solution will allow you to write-off active car loans, student debt, alimony payments, child support, criminal fines or taxes owed to the IRS. However, it is possible to clear credit card debt, deficiencies on repossessed vehicles, unsecured loans, repossession deficiencies, business debts and negligence claims.

How are FICO Credit Scores Affected?

Your FICO credit score is made up of a number of different parts. The amount you owe relative to how much you earn accounts for up to 30% of your overall score. Filing for chapter 7 bankruptcy and debt settlement negotiation can both help to reduce your income-to-debt ratio.

The problem with debt relief is that it involves defaulting on credit agreements. Your repayment history accounts for 35% of your score. It is necessary to reduce your income-to-debt ratio in order to avoid financial difficulties.

The effect of debt settlement negotiation won't be as serious as declaring bankruptcy. Filing under chapter 7 will show on your credit report for a period of 10 years, whilst debt settlement will show for 7 years.

Is Bankruptcy vs Debt Consolidation Easier to Recover From?

Neither filing for chapter 7 bankruptcy or debt settlement negotiation are impossible to recover from. It will be possible to get credit in the future, provided that you make repayments in-full and on-time now and in the future.

Credit repair is not an instantaneous process. Although chapter 7 is the most difficult debt solution to recover from, reliable repayment will start to increase your FICO credit score within a couple of years. Although difficult to quantify, your credit will start to recover 7 to 8 months after your final payment.

Is Bankruptcy vs Debt Consolidation: 2 Important Questions to Ask Yourself

Do you have sufficient disposable income to be able to make repayments towards a debt relief program? If you have $30,000 of credit card debt, you will need to pay $480 for 36 months. This includes the 15% management fee, but also assumes a 50% debt reduction.
Do you have non-exempt assets to protect that would be lost by filing for chapter 7 bankruptcy? Whilst the rules vary considerably between states, non-exempt assets (a second home, valuable collection, sports car etc) will need to be handed to a trustee in order that they can be sold.

The bankruptcy vs debt consolidation decision may seem difficult, but answering the above questions will help you to decide which option it is possible to proceed with. Always talk to a qualified debt counselor before proceeding with any debt solution.

Disclaimer: This article in no way attempts to provide legal, financial or tax advice. One should consult a licensed attorney, tax advisor, or other qualified financial professional before proceeding.

Updated: 21 March 2011