Bankruptcy vs Debt Consolidation

Debt consolidation and bankruptcy are two options for individuals who are struggling with financial woes. When it comes to the question of bankruptcy vs. debt consolidation, it’s important to consider the pros and cons of each option. Then, consumers must weigh these factors against their personal circumstances.

What is Bankruptcy?

Bankruptcy is the process established to allow individuals and companies to eliminate or “wipe out” their debts, under the guidance of the courts.

bankruptcy vs debt consolidation

Which Debt Relief Option is Right for You?

There are numerous forms of bankruptcy, each one designed for a different entity or situation. For instance, Chapter 7 bankruptcy entails requesting the courts to “discharge” the debts that you owe, whereas Chapter 13 bankruptcy entails reorganization of debts. So rather than wiping out an individual’s debts, an individual going through Chapter 13 bankruptcy will submit a repayment proposal. The court then evaluates the plan and the individual’s ability to repay the debts.  Some debts may be repaid in full, some in part, or some may be discharged if the court agrees that repayment would create a situation of “undue burden.”

According to the United States Courts website,, “The procedural aspects of the bankruptcy process are governed by the Federal Rules of Bankruptcy Procedure (often called the “Bankruptcy Rules”) and local rules of each bankruptcy court.” Therefore, the rules of bankruptcy vary a bit from state to state.

It’s also important to note that there are a number of debts that cannot be included in a bankruptcy. They include:

  • tax debts;
  • child support;
  • alimony; and
  • federal student loans.

Though, notably, in the case of federal student loans, it is sometimes possible to get the debt discharged if the individual can prove that repayment would cause a tremendous burden. It’s important to note that the “undue burden” criteria is quite stringent and many individuals do not qualify.

In addition, creditors can contest a debtor’s plans to discharge a debt as part of a personal bankruptcy. The creditor does have the right to appear before the court to request repayment. If the court agrees, the debt will not be discharged, and therefore, the individual will continue to owe money to the creditor, even once the bankruptcy is completed.

One major benefit is that creditors can no longer attempt to collect on a debt once the individual files bankruptcy. Once the filing is submitted to the courts, an automatic stay is issued, thereby preventing collection activities.

What is Debt Consolidation?

Debt consolidation entails taking out one loan in order to pay off multiple debts. Debt consolidation usually involves taking out a low-interest secured loan – which involves offering up collateral against an asset, such as a house — in order to pay off unsecured debts with higher interest rates. Credit cards are a great example of an unsecured debt.

So instead of making multiple payments to five credit card companies each month, the debtor can pay off the credit cards, and they’ll make a single payment to pay off the low-interest rate loan. It’s not just more convenient; it also results in significant savings due to the lower interest rate and the faster repayment (so there’s less interest paid over time.)

It’s important to note that consolidation can impact an individual’s ability to discharge debts if he or she ultimately resorts to bankruptcy.

Many debt consolidation firms also offer help to debtors who are in trouble. Some debt consolidation firms offer consolidation loans. But most negotiate with debtors and collection agencies on the debtor’s behalf in an attempt to lower the interest rate and/or the total amount owed. Some of the savings are passed along to the debtor, though you won’t see 100% of the savings that were negotiated on your behalf, as the debt consolidation firm must keep a percentage of each month’s payment as a fee.

Pros and Cons

When discussing debt consolidation vs. bankruptcy, one major “con”  for bankruptcy concerns eligibility. There are stringent guidelines that determine bankruptcy eligibility, so not everyone qualifies. Conversely, debt consolidation is an option that’s available to virtually everyone.

The major downside of the debt consolidation option is that you’ll be placing your home or other assets at risk if you use them as collateral for a debt consolidation loan. Foreclosure is a very real danger if an individual defaults on a loan that utilizes property as collateral.

Another major bankruptcy vs. debt consolidation consideration involves the assessment process that bankruptcy filers must endure. The court conducts a detailed review of an individual’s assets, finances and belongings as part of the bankruptcy proceedings. This usually involves reviews of bank accounts, properties, vehicles, and even a visit to the person’s home.

The process can be fairly invasive and many feel it’s a violation of their privacy. Some find it off-putting that such a large amount of very personal information is thrust into the public domain, as the asset and financial information is all included in court documents – these ultimately become a matter of public record.

On the other hand, debt consolidation programs allow for much greater privacy and personal information is not thrust into the public domain.

In addition, when considering the question of debt consolidation versus bankruptcy, it’s important to remember that with bankruptcies, the process can drag out for many months, even years and in the end, the debtor may still need to spend years making payments to creditors (in addition to paying the bankruptcy attorney’s legal fees!) So it can literally take years to get back on track.

With debt consolidation, the process typically gets underway fairly immediately and with any luck, the debts can be resolved within a matter of two or three years. So individuals who opt for debt consolidation can often begin re-building their lives much sooner.

While, in theory, the court may discharge each and every one of an individual’s debts,  if this occurs, it means the debtor will be ineligible to receive another discharge for the next eight years. It’s an important consideration.

There is no such restriction when it comes to debt consolidation.

Bankruptcy vs. Debt Consolidation – Conclusion

When considering bankruptcy vs. debt consolidation, there’s no “right” or “wrong” answer. Some individuals are better served by filing for bankruptcy, whereas others will prefer debt consolidation.

If you’re unsure of which option is best for your situation, you may wish to consult a bankruptcy attorney, an experienced financial planner, a debt consolidation expert, or all three to obtain a consultation.