Debt Consolidation v. Bankruptcy

Debt consolidation involves reorganzing all of your individual debt payments into one "manageable" payment. However, throughout my many years of experience as a bankruptcy attorney I have encountered several problems with debt consolidation.

1. Continued Contact from Creditors

Proponents of debt consolidation often mention privacy as one of the biggest draws to entering into a debt consolidation. However, the price for privacy may be high. Depending on the type of debt consolidation you are engaged in, you may not be dealing with all of your creditors at once. Therefore, if you are in a debt consolidation and the company you are using is only consolidating one or a few of your debts at a time your creditors can and will continue to contact you and may even file a lawsuit against you for monies owed. In contrast, upon filing for bankruptcy the automatic stay is put into effect which prohibits creditors from engaging in any sort of collection activity against you, including but not limited to: phone calls, lawsuits, garnishments, repossessions and foreclosures.

2. Limited to Unsecured Creditors

Generally, debt consolidation and thereby debt consolidation companies can only deal with unsecured debts, i.e., credit card or medical bills. Therefore, if you are experiencing financial difficulties with secured creditors, i.e., your home mortgage or car payments, debt consolidation will be unable to assist you with that. Bankruptcy deals with both secured and unsecured creditors. Depending on your situation, if you are experiencing difficulties paying your home mortgage or car payments you may qualify to reduce the interest rate on your vehicle loan and/or save your home from foreclosure.

3. Credit Score and Balance Owed

If you are in a debt consolidation and the company you are utilizing is only consolidating one or a few of your debts at a time your creditors will continue to report late payments and the interest, late fees, and balance owed will continue to accumulate until these debts are dealt with. This will continue to negatively effect your credit score. While a bankruptcy filing does in fact lowers your credit score, if you are already in default you may already have a poor credit score. A benefit of the bankruptcy is that once a discharge is received you will have a “fresh start.”

4. Tax Consequences

Creditors are required to report the settlement of debt to the Internal Revenue Service. This then gets imputed as “income” and you may, depending on your financial situation, have to pay taxes on it. Bankruptcy eliminates your debts, which are not imputed as income and thereby not taxable.

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