Beware of alternatives that don't provide a financial reset.
When you're dealing with overwhelming debt, there's no shortage of ideas out there to help you get out of debt. One option that is sometimes pitched as a debt relief strategy is debt consolidation; that is, combining your various debts into a single debt that you then pay off. Unfortunately, while debt consolidation can be a useful tool for some debtors, it doesn't provide the true financial reset that bankruptcy does — and it can actually make your situation worse in some circumstances.
What is debt consolidation?
Fundamentally, debt consolidation is the process of taking out a new loan and using it to pay off your existing loans. Usually, this new loan is a personal loan from a bank or credit union, a home equity line of credit (if you own a house), or a credit card balance transfer. Some consumer credit counseling agencies also offer a form of debt consolidation. Regardless of the option you choose, debt consolidation doesn't actually reduce the total amount of debt you have; it merely combines your debts into a single, larger debt.
One benefit of consolidating your debts is that you only have to make one monthly payment instead of several — although, in the age of online payments, that doesn't help as much as it used to. You may also get a lower interest rate on the consolidated debt, and you can benefit from moving debts from revolving accounts (like credit cards) to a one-off personal loan, making it harder to rack up more debt if you then close your revolving accounts.
On the other hand, debt consolidation has several potential disadvantages:
- Depending on the type of loan, you may only save on interest in the short term. For instance, many credit card balance transfers offer an introductory 0% interest rate which will shoot back up after 12 or 18 months. While this buys you some time to pay off the balance, it can also blow up your budget if you're not prepared to start paying that interest when it kicks in.
- It's possible to end up with double debt if you transfer your credit card balances but don't immediately close the credit cards. All it takes is one unexpected car repair or other significant expense on a credit card, and you're deeper in debt.
- It's a new loan, which can affect your credit score and eligibility to file for bankruptcy in the near term.
How bankruptcy differs from debt consolidation
Unlike debt consolidation, bankruptcy actually discharges (wipes out) your debt. For example, if you file for Chapter 7 bankruptcy, all your dischargeable debts (including credit cards, medical debt, personal loans, and more) will be wiped out in about four months. Debt consolidation has more in common with Chapter 13 bankruptcy, which rolls your debts into a repayment plan for three to five years — but Chapter 13 still wipes out the debt that remains after the repayment plan is complete, while debt consolidation does not.
The key takeaway here is that you cannot borrow your way out of debt. If you're not in a position to pay off your debts, then consolidating them isn't going to change that. In other words, while debt consolidation can be helpful for some debtors in some circumstances, it is not a bankruptcy alternative.
If you are in overwhelming debt and considering whether bankruptcy is right for you, we would be glad to listen to your story and explain your options in a free consultation. Don't make a major change to your finances without knowing your rights and options. Give us a call or contact us online today to talk to a bankruptcy lawyer at Benjamin R. Matthews & Associates.