A balancing act, dealing with debt can lead to significant consequences if the ball is dropped. It is good to take stock of the situation before making any decisions on how to proceed.
Debt consolidation
As the name suggests, debt consolidation is the process of combining all debts into one for easier management. It is an efficient way of reducing the interest rate and the amount owed on monthly payments.
The following are many options for achieving this:
- A credit counseling agency can assist you in consolidating your debts. Until the debt is cleared, they can collect your monthly payments and use the money to pay off your creditors in accordance with the schedule agreed upon.
- A bank, credit union, or internet lender can provide a debt consolidation loan. For the most part, loans have costs attached to them, and your credit score has an impact on your interest rate. Good credit scores often translate to lower interest rates.
- Contacting your credit card issuers and negotiating a reduced interest rate for repayment: Creditors are under no obligation to agree to your terms of payment.
- The best course of action is to do some research first and weigh the benefits and drawbacks of different approaches. A non-profit credit counselor can help you by offering guidance and suggestions throughout the process.
Pros and cons of debt consolidation
Pros
- It enables one to combine all outstanding loans into a single payment each month.
- Savings on interest costs during the loan’s life may be achievable if you qualify for a reduced interest rate.
- The debt consolidation loan has a specified payoff date, so you’ll know exactly when you will finish servicing it.
- It is unlikely to have a negative impact on your credit score. If your score drops a few points as a result of the lender’s hard inquiry, it should rise again in the following months. Your credit score may even improve if you pay back your loan on time.
Cons
- If you have bad credit, your alternatives are limited because personal loans normally require good to exceptional credit. Lenders that provide personal loans to borrowers with negative credit charge higher interest rates than those who give loans to people with good credit.
- It does not result in the discharging of your payments obligation, as is the case with bankruptcy.
- Some personal loan providers levy costs, such as origination fees, increasing the overall cost.
- It may not be a long-term answer if you can’t stop yourself from accruing more debt.
Bankruptcy
Bankruptcy is a legal process that aims at evaluating the financial position of an individual or institution to prove whether they are incapable of meeting their financial obligations. It also goes as far as developing mechanisms for eliminating some of the debt owed.
Even with a lower interest rate or reduced monthly payments, you may find that after looking at your bills and income, you are unable to pay what you owe. If that’s the case, declaring bankruptcy may be your only option.
There are two types of personal bankruptcy, namely Chapters 7 and 13.
- Chapter 7: In this kind of filing, you must sell all of your assets except those that are excluded from sale under the terms of your contract. Household products such as clothing, furniture, linens, and work instruments may be exempt from this rule.
Property that is not exempt from the proceedings is either sold or surrendered to satisfy the court order. Your other debts will be forgiven after that is accomplished.
- Chapter 13: If you file under this type of bankruptcy, you may be able to keep specific assets. However, you have to pay back non-discharged debts over a three- to five-year period, usually in monthly tranches to an administrator.
Pros and cons of filing for bankruptcy
Pros
- It allows you to get some debt off your back.
- Despite the fact that bankruptcy hurts your finances, it also gives you a fresh start. This may be well worth it for some borrowers.
- Short life span: A Chapter 7 bankruptcy can be completed in as little as six months, whereas a Chapter 13 can take anywhere from three to five years to complete.
- It does not necessitate strong credit or the presence of a cosigner. This makes it more convenient than going for a debt consolidation loan.
Cons
- It’s possible that filing for Chapter 7 will result in the seizure of non-exempt assets.
- Its effects on your credit rating last for a long time: Depending on the type of bankruptcy you filed, the entry will remain on your credit reports for seven to ten years. It’s possible that this will make it more difficult to get new loans in the future.
- If you have credit card debt or medical costs that can’t be discharged in bankruptcy, you may still be able to gain some of that relief. However, it’s impossible to get rid of things like college loans and back taxes, as well as alimony and child support obligations.
- It is a legal process that can be expensive because of filing fees, attorney expenses, and court fees.
Which choice is right for you?
It may be prudent to consolidate your debt if it results in long-term financial security. A consolidation is an option if you’re in debt for a specific reason, such as medical payment, or if you’ve lacked financial discipline in the past and are now determined to improve your situation.
In a short period of time, consolidating your obligations and making on-time payments can raise your credit score. But if you can’t change your spending habits, then it won’t help and may even make things worse for you.
If consolidating your debt won’t make it easier to pay off your debt in five years or isn’t an option due to your financial situation, bankruptcy can be your best alternative due to your financial situation. It removes debts, but it blemishes your credit report for seven to ten years afterward. When you stick to a budget, it can help protect important assets like your house or a classic car.
But, not everyone can declare bankruptcy. Chapter 13 limits your debts to a certain amount and necessitates that you have a steady source of income. On the other hand, your monthly income must be less than the median income for a family your size in your state in order to qualify for Chapter 7.
A debt advisor can help you sort through all of the factors so you can make an informed decision.
In summary
Consolidation of debt and bankruptcy can help improve an individual to manage their debt better. By consolidating, you will be combining all of your monthly payments into a single one. For those who cannot pay their bills and are in need of protection from the court, bankruptcy can be a feasible option.
