Should I File For Bankruptcy or Try Debt Relief?

When you face overwhelming debt, you need to understand your options. Your choice depends on how much you owe, your credit goals, and how quickly you need relief.

Several debt relief strategies exist. Each has unique benefits and drawbacks.

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

Debt relief is a broad term. It includes many different strategies for managing debt.

Common debt relief options include:

• Budgeting and DIY payoff strategies like the debt snowball or avalanche method
• Debt consolidation or refinancing to lower interest rates
• Debt management plans through credit counseling agencies
• Debt settlement to negotiate reduced balances
• Personal bankruptcy (usually Chapter 7 or Chapter 13)

Bankruptcy is itself a debt relief option. Many people view it as a last resort.

But bankruptcy is a powerful legal process. It gives people in crippling debt a financial fresh start.

Bankruptcy isn’t right for everyone. You need to understand all your options first.

Where Are You on the Debt Relief Continuum?

Think of debt relief options as a toolbox. Each tool works for different financial challenges.

If you don’t have much debt or have disposable income, start with self-help methods. Budgeting and DIY strategies can give you more control.

If you’re overwhelmed with high-interest debts like credit card bills or medical expenses, reach for different tools. Consider seeking guidance from a credit counselor to explore debt management plans or consolidation loans.

If you feel completely stuck and unsure how to proceed, comprehensive solutions exist. Debt settlement or personal bankruptcy can help you manage debt effectively.

A free consultation with a nonprofit credit counselor is a smart starting point. Their job is learning about your specific situation and goals. They’ll suggest a tailored plan to help you deal with debt.

Our partner Cambridge Credit Counseling offers free consultations with certified counselors who can assess your situation.

Understanding Your Debt Relief Options

Most debt relief discussions focus on four main strategies. These include budgeting, consolidation, debt management plans, and settlement.

Here’s what you need to know about each option.

Budgeting

Most people understand budgeting basics. You examine your income and expenses.

Then you see how much money remains for debt repayment. If nothing’s left over, you need to increase income or cut expenses.

If neither is possible right now, consider a debt relief program.

Pros of budgeting:

• Increases financial control and awareness
• Helps you avoid new debts by optimizing spending

Cons of budgeting:

• Requires discipline and time to see results
• Might not work for high debt loads

Debt Consolidation and Refinancing

People pursue consolidation and refinancing for the same reason. They want lower interest rates and more affordable monthly payments.

Each strategy works for specific debt types.

For unsecured debts like credit cards, medical bills, or student loans, use debt consolidation. You can get control of payments and save money over time.

For secured debts like home or car loans, consider refinancing. You can also contact your lender directly to request lower rates.

You typically need good credit to consolidate debt or refinance loans.

Pros of debt consolidation and refinancing:

• Simplifies multiple debts into one payment
• Often reduces interest rates and monthly payments

Cons of debt consolidation and refinancing:

• Might extend the debt period, increasing total costs
• Requires good credit for the best terms

Debt Management Plans (DMP)

A debt management plan is a 3-5 year structured repayment program. It handles large debts from high-interest credit cards, medical bills, and personal loans.

You can’t do this alone. A credit counselor creates and manages the plan for you.

They work to lower your interest rates. They often get extra fees like late charges dropped.

A DMP streamlines debt repayment. It reduces monthly payments and ultimately saves you money.

You make one monthly payment to the counseling agency. They may add a small service fee.

Pros of a debt management plan:

• Organizes your debt with help from financial experts
• Creditors may lower interest rates and waive fees

Cons of a debt management plan:

• May involve setup and monthly fees
• May take longer than other debt relief methods

Debt Settlement

Debt settlement involves negotiating with creditors. You offer a lump sum that’s less than your total debt.

If the creditor agrees, they cancel the remaining balance. Debt settlement doesn’t always work.

Not every creditor is willing to negotiate.

Settlement works best when you’re already behind on payments. Creditors must think they might not get paid at all.

If you’re current on accounts, this approach is unlikely to succeed.

Pros of debt settlement:

• Can reduce the total amount you owe
• Allows faster debt clearance than other options

Cons of debt settlement:

• Works best with a lump-sum payment ready
• Creditors may take legal action after missed payments
• You may owe taxes on forgiven amounts

Exploring Bankruptcy as a Debt Relief Option

Chapter 7 bankruptcy allows people overwhelmed with debt to get a financial fresh start. It’s the most common type of personal bankruptcy.

Some individuals don’t qualify for Chapter 7. Their income is too high or they own assets they don’t want to lose.

These individuals may choose Chapter 13 bankruptcy instead. Chapter 13 is the second most common type.

What Is Chapter 7 Bankruptcy?

Chapter 7 bankruptcy is a legal process. It helps individuals or businesses eliminate debts they can no longer pay.

People call it “liquidation” bankruptcy. In theory, it can involve selling property to pay creditors.

But this is very rare. Most property can be kept if it falls under exemptions.

Basic household furnishings, clothes, and sometimes your car are protected from sale.

When you file your case, most collection actions pause immediately. Calls, letters, and lawsuits must stop.

Courts call this pause an “automatic stay.”

A court-appointed trustee oversees your case. They review your finances and manage any non-exempt property sales (which again, rarely happens).

When your case is approved, remaining unsecured debts are discharged. You’re no longer legally required to pay credit card bills, medical expenses, or personal loans.

Benefits of Filing Chapter 7 Bankruptcy

Some people view bankruptcy as a last resort. But if you’re truly struggling financially, it offers a fresh start.

Chapter 7 bankruptcy has significant advantages:

✅ It usually takes only 4-6 months. Chapter 7 eliminates most debts within 4-6 months. No lengthy payment plan required.

✅ It stops creditors’ collection efforts. Creditors must obey bankruptcy laws. They can’t continue collection efforts after you file without court approval. All the phone calls stop immediately.

✅ After discharge, collections stop permanently. Creditors aren’t permitted to collect discharged debts. They face severe penalties for violating discharge orders.

✅ It stops wage garnishment. Chapter 7 bankruptcy stops wage garnishment, lawsuits, and other collection forms.

✅ It erases deficiency judgments. If you surrender your car or house because you can’t afford payments, creditors can’t get deficiency judgments. Existing deficiency judgments are discharged.

You can speak with a bankruptcy attorney for free to see if Chapter 7 is right for you.

Drawbacks of Filing Chapter 7 Bankruptcy

Chapter 7 bankruptcy offers debt relief and a fresh start. But you need to understand potential downsides first.

Here are the key disadvantages:

❌ It affects your credit score. If you have good credit, filing Chapter 7 will hurt your score. Bankruptcy stays on your credit report for up to 10 years. Getting new credit or good interest rates becomes harder.

❌ You may lose non-exempt property. Most individuals keep all essential property. But if you have non-exempt assets, trustees can sell them to pay creditors.

❌ Not all debts are dischargeable. Chapter 7 eliminates many unsecured debts. But certain obligations like child support, alimony, and some tax debts typically can’t be discharged. You’ll still owe these debts after bankruptcy.

❌ It can be stressful and time-consuming. Filing for Chapter 7 involves extensive paperwork and legal procedures. You’ll need financial documentation, credit counseling sessions, and possibly court appearances. The process can be emotionally taxing.

Can You Get Rid of Student Loans in Bankruptcy?

Sometimes. You’ll need to file an adversary proceeding (AP) after filing your bankruptcy petition.

During the AP, you must prove you meet an “undue hardship standard.”

The Department of Justice released new guidance in late 2022. Courts now interpret the undue hardship standard more uniformly.

Since then, discharging some student loans has gotten easier. Federal student loans are the main focus.

You can try to discharge private student loans too. But the AP process will be more complicated.

Some unsecured debts aren’t eligible for discharge. Student loans aren’t dischargeable unless you qualify for hardship discharge.

Most income taxes, alimony, and child support payments also aren’t dischargeable. You can’t escape domestic support payments by filing Chapter 7.

Comparing Debt Relief and Bankruptcy

Debt relief and bankruptcy work differently. Understanding these differences helps you choose the best option.

When To Consider Debt Relief Over Bankruptcy

Debt relief might be better than bankruptcy in some situations. Here’s when debt relief could help more:

• You have a manageable amount of debt. If you think you can repay your debt with a good plan and time, try debt relief before bankruptcy.
• You want to protect your credit score. If you have good credit and want to keep it, debt relief is a better choice.
• You’re confident you can stick to a plan. Most debt relief options require patience and persistence. If you have both, debt relief works well.

When To Consider Bankruptcy Over Debt Relief

Bankruptcy might be the better option in these situations:

• You have overwhelming debt. If your debt far exceeds what you can repay, bankruptcy gives you a fresh start. Chapter 7 erases most unsecured debts like credit cards and medical bills.
• You want to stop debt collectors immediately. Bankruptcy stops all collection actions right away. Calls, letters, and lawsuits must cease. If creditors are harassing you, this immediate relief helps tremendously. Bankruptcy also protects you from lawsuits and wage garnishment.
• Other debt relief options haven’t worked. If you’ve tried debt relief without success, bankruptcy might be your only choice. People with extensive medical bills, credit card debt, or personal loans often reach this point.

How To Choose the Best Option for Your Financial Situation

Start by asking yourself one question. Can I repay this debt without harming my essential living expenses and financial stability?

If your answer is “yes,” even with a few years and outside help, explore debt settlement, consolidation, or a debt management plan. A free session with a nonprofit credit counselor can be invaluable here.

If your honest answer is “no,” Chapter 7 bankruptcy might be your best choice. Many people, despite their best efforts, can’t cover basic needs and pay off debt.

High credit card interest rates, expensive medical bills, large student loans, stagnant wages, life emergencies, or bad luck often cause this.

You’ll also want to answer these questions:

• What is the total amount and type of debt you have?
• How much will each option cost? Can you do it yourself or need help?
• How long will each option take? Can you stick with it?
• How flexible does your repayment plan need to be?
• How important is your credit score right now? Will this option help meet your financial goals?
• Are you worried about lawsuits or wage garnishment if you don’t address debt soon?

Getting professional guidance can make all the difference. You can speak with a bankruptcy attorney for free to discuss your options and find the path that works for you.