Debt Consolidation vs. Bankruptcy: What’s the Difference?

If you’ve racked up debt you’re now struggling to pay, it’s easy to feel like you don’t have good options to restore your financial stability and dig yourself out of this hole.

Whether it’s medical debt, consumer debt or a mix of different kinds of debt you’re unable to pay, it’s important to remember that even when your circumstances appear grim, you have options to be proactive and address your existing debt.

Among those options, debt consolidation and bankruptcy are common strategies used to take control of debt that has grown beyond your control. While these processes may look similar from the outside, they actually have important differences and implications consumers should understand.

With that in mind, here’s a quick comparison of the debt consolidation vs. bankruptcy processes.

Debt consolidation can help you avoid legal trouble.

If you’re worried about unpaid debt and its potential to result in liens or other legal actions against you as a consumer, debt consolidation can be a very effective strategy for paying off those debts, moving debt into a new account and giving you a longer timeline to repay what you owe.

By contrast, bankruptcy will inevitably bring you to bankruptcy court and create a lot of additional legal hoops for you to jump through. Even if bankruptcy offers a path to legal resolution of your debts, you’ll spend a lot more time and energy dealing with the legal implications of your inability to pay back your debts.

Bankruptcy can offer a faster path to a fresh start.

If paying off your debt is not an option, bankruptcy may be the fastest way to get past your debts and get a restart on your financial situation — at least in terms of resolving your debt obligations.

Consumers should keep in mind that there are significant disadvantages and consequences to declaring bankruptcy; the effects of bankruptcy will linger long after the bankruptcy process is finished. Still, some consumers may not have any viable alternatives — and declaring bankruptcy can help shield you from more serious financial ramifications.

Debt consolidation is more favorable to your credit score.

Bankruptcy can help you resolve your debts faster, but it leaves a powerful negative mark on your credit reports that will linger for 7-10 years, making it much tougher to qualify for credit during that period of time.

Debt consolidation is potentially more costly and takes longer to resolve, but it can help you improve your credit score faster through timely payments, gradually reduced debt resolution and the avoidance of serious marks like those a bankruptcy causes. 

Bankruptcy will likely impact your ability to get credit in the future.

If you decide that bankruptcy is your best option going forward, you should be prepared for the limitations this may create in the future.

Most significantly, bankruptcy will likely lower your credit score significantly — especially in the years shortly after this declaration. This could affect the rates you receive when applying for loans in the future, and it may prevent you from qualifying for a wide range of credit, including auto loans or a mortgage.

Qualifying for debt consolidation and bankruptcy is not always guaranteed.

Neither debt consolidation nor bankruptcy is an automatic process. If you decide you want to consolidate your debt, you’ll need to be approved for a debt consolidation loan from a lender. This approval process will take into account your credit score, income and current amount of debt — and it’s possible that the existing debt you owe may be a barrier to qualifying for debt consolidation.

Bankruptcy also has its own requirements to be eligible to apply. If you are considering bankruptcy, you will need to confirm these requirements and your eligibility with your local bankruptcy court based on the type of bankruptcy you are declaring.

As you evaluate debt consolidation vs. bankruptcy, consider not only your short-term financing needs but also the long-term impact each process could have on your creditworthiness and your financial outlook. Choose the debt resolution process that will give you the best opportunity to rebuild your finances and look forward to a brighter future.

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