Debt Consolidation vs. Bankruptcy

Millions of Americans are in big financial trouble in these trying economic times. If you're one of them, you may be thinking about consolidating your debts or getting help through credit counseling. Before you do anything, make sure the course you take will be the one that's best for you.

Debt Consolidation

When you consolidate your debts, you are taking all of your individual debts such as credit cards, loans, and medical bills, and combining them into one monthly payment instead of several. You can do this through a credit counseling service, or by taking out a home equity loan and using the proceeds to pay off your other debts.

If you use a credit counselor, he or she usually negotiates with the lender to get a reduced interest rate and monthly payment for you on each of your debts. You send the credit counseling company one check each month, and the counselor divvies up the funds between your creditors. Through this plan, you can expect to be free of your debts within three to five years. Debt counselors can also get rid of late charges you may have accrued.

The problem with debt consolidation is that, having once agreed to it, if you find that you are unable to stick with the plan, you usually cannot back out. Filing for bankruptcy will do no good, particularly if you have consolidated your debt into a home equity loan. This changes your unsecured debts into secured debt, so you would be unable to get it discharged in bankruptcy without losing your home in the process.

Bankruptcy

It's never pleasant to realize that you cannot pay your debts. It can make you feel like a failure, and you begin to wonder if you're just plain bad with money. You may feel embarrassed or ashamed that you're considering bankruptcy. Money management, like anything else, is a skill that can be learned, and everyone makes mistakes to some degree. All you can do is learn from those mistakes and do better in the future. Bankruptcy can provide you with a fresh start.

Not every debt can be discharged in bankruptcy, however. Child support payments, federal income tax, and federal student loans are examples of some non-dischargeable debts. Also, if anyone has recorded a monetary judgment against you, that would also remain.

If you decide to file for bankruptcy, keep in mind that this black mark will remain on your credit report for ten years.

Financial Consequences of Bankruptcy

Once your bankruptcy has been discharged, you will need to begin rebuilding your credit. You can obtain a loan for a vehicle right away, but keep in mind that you will probably pay more interest than someone without a bankruptcy on his or her credit report. Credit card companies will approach you, but be sure to read the fine print: many of them will want to charge you an annual fee, and others will require advance payment (i.e., a "pre-funded" credit card). The magic number for obtaining a home loan is two: two years after discharge, you will be eligible for a home loan. If you already have a home, you will not lose it in bankruptcy.

Your credit score will suffer for some time after a bankruptcy filing, but this doesn't necessarily have that much impact on your life. It all depends on you. Pay your bills on time, and even early if you can; if your vehicle insurance rate rises because of the bankruptcy, try to negotiate with the insurance company. For instance, if you are a longtime customer, they may be able to give you a break.

Decisions, Decisions

Check into all of the options available to you, talk to a bankruptcy attorney, and make the decision that best suits your situation. You can recover from financial disaster; be patient and do your best to remain solvent.