Filing Bankruptcy vs. Debt Consolidation
What is Debt Consolidation?
Debt consolidation sounds great and is a good way to handle a minor to moderate cash flow problem. When too many monthly bills come due and it is a struggle to pay all of them on time, one of the first logical thoughts is to get one new, larger loan and pay off all the individual debts.
Often, a consolidation loan has a longer term and an overall lower interest rate making it an affordable option that is much easier to handle. This is especially true when your multiple individual debts are at high interest rates, which ordinarily means that payments will go on for multiple years, perhaps decades.
Yet, what sounds so desirable is not obtainable for everyone.
First, you must have sufficient income and good credit to qualify for a consolidation loan.
Second, your total debt needing consolidation cannot be so large that even a consolidation loan won’t really fix the problem.
Third, some type of collateral is frequently necessary for larger consolidation loans, such as a 2nd mortgage on a house.
In short, getting a decent consolidation loan really means that your financial situation cannot already be dire. You must have good credit, income, and credit history to even qualify for a legitimately helpful and practical solution to short term cash flow problems.
What is Bankruptcy?
Bankruptcy is a formal and legal process where you seek protection from your creditors. Bankruptcy can quickly provide you with a complete financial solution to overwhelming debt.
There is more than one type of bankruptcy for individuals, which is normally either a Chapter 7 or a Chapter 13. It takes a deep dive into bankruptcy law and consulting with a bankruptcy professional to learn the pros and cons of each type is highly recommended due to the complexity involved.
However, in a nutshell, filing bankruptcy is all about financial relief from nearly impossible financial difficulties. Bankruptcy relief can mean a relatively fast “wipe-out” of your debts and a fresh start after it is completed. Or, bankruptcy can mean giving you breathing room to handle your most important debts, such as a house or car debt, over 3 to 5 years.
No two bankruptcies are exactly alike and what may work for one individual could be the wrong decision for another. Getting bankruptcy-specific professional advice is crucial and what you pay in fees for that advice and legal representation is invaluable.
What is the difference between the two, i.e., Chapter 7 and Chapter 13?
As touched upon above, people normally file a Chapter 7 or a Chapter 13 bankruptcy. A good candidate for a Chapter 7 bankruptcy is ordinarily someone who doesn’t own a lot of assets (or ones that they care to keep) AND don’t have high income.
Chapter 7 cases commonly revolve around people with average income, below income (for their location) or no income at all. For consumer cases (as opposed to business related cases), a Chapter 7 debtor must effectively pass the “Means Test.” The income earned in the last six months prior to filing a case is compared with the median income earned by others in your area of the country. If you make meaningfully more than your fellow citizen with the same size household and circumstances, then a Chapter 13 bankruptcy becomes the better option. However, there are many exceptions for an experienced bankruptcy attorney to consider. Do you or members of your family have non-covered health expenses? Do you have daycare expenses?
Multiple factors must be considered to determine if you qualify for a Chapter 7 bankruptcy. The other part about Chapter 7 that is crucial is whether or not you have important personal or real property to protect. Even if you qualify for Chapter 7 does not automatically mean that it is the best choice for you, again, depending on the assets you have and whether you want to keep them.
Chapter 13 gets you to the same place as a Chapter 7 but gives you time to pay back SOME of your debts over three to five years. Both Chapter 13 and 7 ultimately are designed to get you a Discharge Order. How you get that discharge order, be it through Chapter 7 and 13, is a matter of income and asset analysis, along with the hopeful accomplishment of a long-term solution to financial problems.
A big misconception is that Chapter 13 bankruptcies require you to pay back all your debts. That is simply not the case in the vast majority of cases. Payback percentages can range from 0% to 100% depending on your income, the type of debts you owe and the assets that you want to keep (like a car or house).
What are the Pros and Cons of a Chapter 7 vs Chapter13?
Chapter 7s are loved by many because they are open and shut, ordinarily, within four months of filing a new case. It’s simply over with and that brings a lot of relief and closer. Most Chapter 7 cases are “non-asset” proceedings, meaning that the Chapter 7 Trustee determined that you don’t have any assets worth taking.
State and federal exemptions do protect some of your assets from the Trustee and each case must be carefully analyzed to make a highly educated assessment of whether a Trustee will claim your assets.
By comparison, Chapter 13s are loved by those who need control and time to work through their financial situation. For example, if your house is set for a foreclosure sale and you are behind $30,000, then what you need is TIME to pay back that $30,000 over the next 3 to 5 years. You, the debtor, are in control of your case and in charge of what you want to keep and not keep.
There is tremendous flexibility with Chapter 13 bankruptcy cases and the debtor is always in the driver’s seat, including what monthly payment is proposed (subject to legal requirements). If a person decides, for whatever reason, that they no longer want to be in a Chapter 13, then all that is needed is a simple Motion to Dismiss, barring any bad faith activities.
What do Each do to Your Credit?
This is a frequently asked question that has a very complex answer. The reason the answer is complex is because there is no absolute standard that applies to future credit ratings.
Technically, a Chapter 7 stays on your credit report for 10 years while a Chapter 13 is reported for 7 years in most cases. However, what the law says can or cannot be reported on your credit report has little to do with your future credit. Ordinarily, and ironically, filing a Chapter 7 is a better way to go if you want to reestablish your credit rating faster.
The reason for this is that creditors are looking for how long your case has been Discharged. Chapter 7 cases get discharged within four months or so whereas Chapter 13 discharges are delayed 3 to 5 years. Again, the type of bankruptcy that is filed is usually much less important as to future credit ratings versus a slew of many other factors, such as the amount of your income post-bankruptcy and your new “debt to income ratio.”
Slowly but surely, credit rating increases post-bankruptcy if the former debtor does not create financial conditions that again put his or her cash flow at risk by taking out too much debt at one time. On the other hand, avoiding all debt, post-bankruptcy, will likely severely damage your future credit rating. You must appear on the “credit radar screen” every now and then to allow a new rating to be developed.
How to Make the Decision Whether to File Bankruptcy
In short, a person contemplating bankruptcy needs good, honest advice from a very experienced bankruptcy-specific attorney. Each field of the law has its own unique features and bankruptcy is certainly no different. A good approach is to make a list of questions and meet with a bankruptcy attorney with a good reputation in your area.
Additionally, don’t be afraid to get 2nd and 3rd opinions. Most bankruptcy consultations, for simple consumer cases, are free of charge whereas more complex cases and business-related cases generally involve a consultation fee due to the time commitment by the attorney.
Finally, try and visit a bankruptcy attorney well in advance of an emergency. By all means, seek one out quickly, if necessary, but try to calmly gather your bills, a recent tax return, some information about your vehicle(s) and a few paystubs and set an appointment. Don’t be embarrassed to meet with an attorney- it is 100% confidential and you are communicating with an attorney that does this type of work for a living.
Bankruptcy or Debt Consolidation: Which is Better?
Filing bankruptcy vs debt consolidation is a worthy discussion but normally, it is not that difficult to determine with the right advice and with a healthy dose of common sense.
The difficult cases are those right at the tipping point between getting a consolidation loan versus biting the bullet and finally filing bankruptcy. The answer is found in some deep soul searching and keeping your priorities in life in focus.
Seeking professional advice is absolutely critical. Chapter 13 vs debt consolidation makes a lot of sense in very difficult cash flow situations. Factors such as family size, dependent children and keeping the household financially stable are key considerations.
If possible and if the qualifications are met, a Chapter 7 bankruptcy vs a debt relief company is the better choice assuming there is no other practical financial solution.
Yet, Chapter 13 vs debt consolidation should be very seriously considered if there are non-exempt assets to protect and/or is sufficient income to pay back a portion of the debt.
The key concept is to find a long-term solution to your financial problems are create stability and sometimes a knee jerk debt consolidation vs bankruptcy is a big mistake. More than a few people have chosen the debt consolidation route and have disregarded any consideration of bankruptcy only to find themselves filing bankruptcy years down the road.
We are Here to Help
The team at John T. Turco & Associates, P.C. has years of experience and we understand overwhelming debt is stressful and frustrating. We specialize in bankruptcy cases in Nebraska and Iowa will help you navigate debt relief through the bankruptcy process.
To speak to an attorney about your debt situation call 402-933-8600 or request a free, in depth consultation.