Debt Consolidation vs. Bankruptcy- Which Should You Choose?

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Ok, so the credit card debt is piling up.  You could have gotten to this place for a variety of reasons.  Maybe you, or your spouse, had a temporary job loss?  Illness?  Divorce?  Bad budgeting? Overspending?  However you get there, for purposes of this article, let’s just assume that you’re there.  Ok, so now what?  If you do what most people do, you’ll head to Google and find all kinds of supposed “magic cures” for your debt woes.  “Financial Freedom in 3 easy steps…”  You may read that the “government has a new program to help people just like you!”  Sounds nice, doesn’t it?  In all reality, you only have a few realistic options moving forward.  We will be focusing on two of them here.

Debt Consolidation

Before coming to see me for a bankruptcy consultation, many people in unfortunate circumstances will unsuccessfully try to overcome their debt problems with what is known as “debt consolidation.”  This term has a few different meanings.  Some debt consolidation companies will attempt to lower the interest rates on your credit cards and combine your debts to help you budget for one manageable monthly payment.  Yet other companies will take your money for many months (or more) and then attempt to negotiate lump sum settlements with your credit card companies to get you out of some of your debt completely.  These results sound helpful and if true, they would really turn your life around.  Unfortunately, what these companies promise and what these companies actually deliver are two very different things.

First off all, debt consolidation companies are “loosely regulated” by the F.T.C., there is little oversight out there (1).  You may think to yourself, “Well this one looks good.  It’s a non-profit.  What could go wrong?”  It turns out; quite a bit can go wrong.  So called “non-profits” often get caught funneling your money to “for-profit” companies through a series of corporate loopholes. The F.T.C. is hitting these companies with some hefty fines (2).

Next, these companies often fail to deliver what they promise.  For example, let’s assume you have 8 credit cards.  What if the consolidation company convinces 5 of these credit card companies to agree to a lower interest rate and one monthly payment?  You still have 3 more to deal with?  There is no law requiring your creditors to agree to anything these consolidation companies are offer.  You could be dutifully paying the consolidation company each month only to be served with a surprise lawsuit filed by a creditor that opted not to participate.

Also troubling are the tax consequences that accompany debt settlement.  Did you know that forgiven debt can be considered taxable income (3)?  So you thought you were solving your problems by getting out of paying some debt to a credit, but now you owe the I.R.S. money?  Unless you have a CPA reviewing your debt consolidation company’s actions, and advising you as to the tax consequences every step of the way, do you really know what you are getting yourself in to?

Finally, there are the credit implications.  So often I hear that people attempt credit consolidation, and avoid bankruptcy, because they are trying to “save their credit.”  While your consolidation company is collecting your money, either to work out a new monthly payment or a lump sum settlement, they are not timely paying your credit card bills.  Your credit is taking a hit right off the bat.  And then, when settlements are made, your credit reports will reflect that “settlements” were made.  Debt consolidation is not some magic cure to save your credit.  So what other options do you have?

Bankruptcy

Bankruptcy is not for everyone, but it is extremely rare that I find a scenario where bankruptcy was not a better option.  While nothing in this world is certain but death and taxes, when you file for bankruptcy you know what you are getting in to.  If you file for Chapter 7, you know that your unsecured debts will be discharged by the court.  If you file for Chapter 13, you have a Plan, confirmed by a judge that will deal with your debt issues.  It’s not like your credit card companies get to decide whether or not they want to participate.  Also, once you file for bankruptcy any lawsuits pending against you are frozen, or “stayed,” prohibiting the creditors from taking further action against you (4).

Will bankruptcy affect your credit?  Of course, but the impact may not be nearly as bad as you imagine.  Check out my previous article http://berkmyer.com/what-will-a-bankruptcy-do-to-my-credit-score/ to learn more about that.  Most often people buried in debt do not have perfect credit to begin with.  That is why they are looking at debt consolidation or bankruptcy in the first place.  Quite often, a bankruptcy allows you to repair your damaged credit.

So, is there a one-size-fits-all cure for everyone’s debt issues?  Absolutely not.  Everyone’s situation is unique and should be dealt with accordingly.  Before rushing into a decision, do your homework.  Research online, get referrals, and educate yourself.  You have options!  A wise first step is taking advantage of Berkowitz & Myer’s no-cost consultations.  Learn about the law and how it might impact your particular circumstances.  Call us to learn more.  We are here to help you.

 

  1. https://www.consumer.ftc.gov/articles/0150-coping-debt
  2. http://www.marketwatch.com/story/scam-debt-counseling-firms-fined
  3. https://www.irs.gov/taxtopics/tc431.html
  4. 11 U.S. Code § 362

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