Last Updated on February 21, 2021 by James Gentile
If you’re feeling overwhelmed with debt, you might be considering a debt consolidation loan – after all, the idea of rolling all those maxed-out credit card bills, massive student loans, car payments, and other financial liabilities into a single payment seems pretty appealing, right? Let’s discuss whether debt consolidation or bankruptcy is your best option.
Debt Consolidation or Bankruptcy – What You Need To Know
In fact, the federal government mandates that people who are considering filing for bankruptcy first participate in pre-filing credit counseling within 180 days of filing, and debt consolidation is one option credit counselors often discuss with their clients.
Unfortunately, debt consolidation programs aren’t quite as simple or as affordable as many people are led to believe. While avoiding bankruptcy through any means necessary might seem like the right choice, all too often, consumers wind up spending more and owning less when they opt for a debt consolidation loan instead of filing for bankruptcy.
The Reality of Debt Consolidation
In most cases, lenders who provide debt consolidation programs will demand collateral against the loan, which usually means leveraging your family home, vehicle, or business. While doing this can help you keep your credit rating and avoid bankruptcy, it’s also a big gamble. Why? Because a debt consolidation loan doesn’t actually reduce the amount of money you owe, it simply restructures your debt into one big payment. Ask yourself this – if you’re already either struggling to make all of your payments or you’re unable to keep up with your current bills, what difference will be lumping everything together make? The fact is that if you really could afford to pay off your debts, you’d have done it already.
When your home, car, or other property is used as collateral against a consolidation loan, if you’re not able to make your loan payments, your collateral will be seized by the lender – you could lose everything and still owe money. Another thing to understand about consolidation loans is the role the IRS plays. Depending on your specific financial situation, the IRS may actually levy income tax against any money you save by lumping your debts together, which can put you in a worse place than you started from.
Bankruptcy or Debt Consolidation
Depending on your current financial situation, filing for bankruptcy may offer some distinct advantages over trying to repay your debts through a consolidation loan. With Chapter 7 bankruptcy, most types of debts, including credit cards, medical bills, and collection agency accounts, are discharged completely, allowing you to start over with a clean slate. Although you will need to forfeit most of your assets, you won’t be expected to make payments on your debts either.
Under a Chapter 13 bankruptcy, you will need to make payments on a portion of your debts for 36-60 months. However, you won’t need to deal with your creditors individually, and better yet, you pay no interest 0% and can actually avoid foreclosure on your family home. In a nutshell, a chapter 13 bankruptcy is similar to a consolidation loan in that you’ll need to make payments on a portion of your debts; however, you won’t risk losing your home as you would under a debt consolidation program.