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The biggest difference between bankruptcy and debt relief is that bankruptcy is a legal proceeding while debt relief is handled privately.
“I just need to stick to a budget. I’ll just get a second (or third) job. I won’t answer the phone or open my mail to avoid creditors. I just need more time.”
It’s human nature to want to fix your problems by yourself, especially something as stigmatized as debt. But the truth is, if you’re in debt and facing severe consequences, outside help like bankruptcy or debt relief may be the best pathway to a fresh start.
Neither option is easy, and there will be consequences, but the credit repair professionals at Lexington Law Firm know that when it feels like you are hanging from the edge of a cliff, it’s okay to ask for help. It’s best to talk to a professional about your situation before making a life-altering decision such as bankruptcy or debt relief, but in the meantime, we’ve assembled the basics of each to help you better understand your options.
Table of contents:
CodePen - Bankruptcy vs debt relief table
| Bankruptcy | Debt Relief |
|---|---|
| Discharges eligible debt to give debtor a new start | Reorganizes debt to make it easier for the debtor to repay |
| No credit score or income required to qualify (except in Chapter 13 bankruptcy) | Handled privately between debtor, creditors and possibly a third party Not all debts qualify |
| Handled in the legal system | Options based on a credit score |
Bankruptcy is a type of debt settlement handled within the legal system. The goal is to balance relieving you of debt with providing your creditors with as much repayment as possible. Because bankruptcy is a legal proceeding, hiring a lawyer is highly recommended.
Generally, when you cannot pay your debts, you can file a bankruptcy petition in federal court. After the proceedings, all or some of your debts from before the petition was filed are discharged or eliminated.
Not all debts can be discharged through bankruptcy, however. If you have any of the following debts, bankruptcy will not discharge them:
Once the petition is filed, creditors must cease all collection-related activity. Once the court issues the discharge order you are no longer legally responsible for any discharged debts.
There are multiple types of bankruptcy, all of which are named after the chapter of the Bankruptcy Code they refer to. The most common types of bankruptcy for individuals are Chapter 7 and Chapter 13.
You can file for Chapter 7 bankruptcy when you have few, if any, assets and your monthly income does not exceed your state’s median income. However, owning many assets does not disqualify you from Chapter 7, it just results in a larger liquidation of assets if they are not exempt.
In this type of bankruptcy, the court creates an estate consisting of all your assets, including collections, stocks, bonds, cash and investment funds. The court appoints a trustee, who is responsible for liquidating the nonexempt assets. The trustee then uses the money from the liquidation to pay off as much debt as possible.
A debtor filing for Chapter 7 bankruptcy is not guaranteed discharge of any or all debt. Discharge may not be granted if you:
If you do not qualify for Chapter 7 bankruptcy, you may be able to file for Chapter 13 bankruptcy. Also known as “wage earner’s bankruptcy,” Chapter 13 bankruptcy allows you to create a debt repayment plan, paid in installments over three to five years while keeping your property.
In order to qualify for Chapter 13 bankruptcy, your debts must be less than $2.75 million. In all forms of bankruptcy, debts are divided into three types:
After filing, you create a debt repayment plan that is submitted to the court for approval. In the plan, all disposable income must be put toward debt reduction payments, which must total:
Within thirty days of filing your plan, even before the judge approves the repayment plan, you pay a monthly payment to the trustee of the case, who then allocates the payments to the individual creditors. This payment can be made via payroll deduction or monthly payments for three to five years, depending on the terms set by the court. After the agreed-upon period, all remaining debt is discharged.
During the repayment period, you cannot acquire new debt without the trustee’s consent. This prevents you from being unable to meet the terms of the repayment plan.
Unlike Chapter 7, in Chapter 13 bankruptcy, you are entitled to be discharged of debt as long as you uphold the terms of the plan approved by the court. However, if at any time you miss any tax, child support or alimony payments during the course of the repayment plan, the bankruptcy case could be dismissed.
In many cases, Chapter 13 bankruptcy is preferable to Chapter 7 since it allows you to keep your property as long as you do not miss any payments.
Filing for Chapter 7 or Chapter 13 bankruptcy can be helpful in a few ways:
The biggest con of filing for either Chapter 7 or Chapter 13 bankruptcy is the damage it can do to your credit. Depending on the type of bankruptcy you file, it may appear on your credit report for seven to 10 years. However, it’s important to remember that if you are in a situation where bankruptcy is a good option, your credit is probably already damaged. In the long run, bankruptcy—and the subsequent debt discharge—may actually benefit your score over time, especially if you take the appropriate steps to rebuild it.
Other cons to consider include:
Bankruptcy is a serious legal process with long-term consequences and should not be taken lightly.
However, if you face severe financial consequences such as repossession and foreclosure, or you have to choose between making minimum payments and necessities like food and shelter, filing for bankruptcy may offer you a fresh start.
If you are considering bankruptcy, it’s important to consult a professional to ensure it’s the best option for your circumstances.
Debt relief is when you reorganize your unsecured debt to make repayment more manageable. This reorganization can include lower interest rates, some debt forgiveness, fewer or lower payments or extended loan terms.
Debt relief comes in many forms, and you’ll want to speak with a professional before deciding which one is right for you.
One option is debt consolidation, or combining multiple debts into one. To consolidate your debt, you can do any of the following:
Debt consolidation may be challenging if you have bad credit, but it’s not impossible.
Other forms of debt relief include:
The biggest pro of debt relief programs is that you can resolve your debt without entering the legal system, as you do when you file bankruptcy.
Cons of debt relief programs include:
The best time to consider debt relief is when you are just starting to struggle with your monthly payments. At this point, your credit health may still allow you to qualify for loans to help you consolidate your debt, and any associated fees will be manageable. Plus, you’ll be able to see results faster and avoid more serious problems later.
At their core, bankruptcy and debt relief both offer relief from your debt and may negatively impact your credit, at least for a time.
The biggest difference between the two is that bankruptcy is conducted through the legal system, while debt relief is handled privately between you, your creditors and a possible third party (like another financial institution or credit counseling organization). Also, debt relief does not guarantee your debt is discharged, and you may end up filing for bankruptcy in the future if the debt relief strategies you choose aren’t enough.
When you are trapped in the undertow of debt, it can be tempting to grab the first lifeline thrown your way. But when it comes to bankruptcy and debt relief, grabbing the wrong one can have lifelong consequences. For that reason, it’s impossible to say definitively whether bankruptcy or debt relief is better for your specific situation without consulting a professional.
Lexington Law Firm offers a variety of services to fit your personal finance needs, specifically when it comes to credit. Start with a free credit assessment to start your journey to better credit.
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