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Debt consolidation vs. bankruptcy: What's the difference?

Credit card debt consolidation and bankruptcy are two very different debt relief options.  Getty Images

If you're dealing with mounting credit card debt, you may feel overwhelmed. After all, with several rate hikes over the last two years, there's a high probability that your minimum credit card payments have increased

If you're struggling to make your minimum payments, you may be thinking about debt consolidation or even bankruptcy as a way to get out of debt. But what are the differences between these two options?

Get in touch with a debt relief pro now to learn more about your options

Debt consolidation vs. bankruptcy: What's the difference?

Credit card debt consolidation is the process of using either a loan to pay off your high-interest credit card balances or taking advantage of a debt consolidation service, also known as debt management, to help make your debts more manageable. 

Bankruptcy, on the other hand, is a legal debt relief avenue by which the courts can require your lenders to discharge your debt (Chapter 7 bankruptcy) or work with you to restructure your assets and debts (Chapter 13 bankruptcy). 

But those aren't the only differences between these two debt relief options. Other differences between the two include:

The credit impact

The impact each option has on your credit is one big difference to note. For starters, bankruptcy can remain on your credit report for up to a decade.

"Filing bankruptcy is one of the most detrimental events for your credit score," says Lamine Zarrad, CEO and founder of the credit-building tool StellarFi. "Additionally, filing for bankruptcy will remain on your credit score for 7-10 years."

Debt consolidation, on the other hand, can also have a temporary impact on your credit score in certain cases. For example, debt consolidation programs may cause a temporary dip to your credit score due to account closures.

Or, if you take out a debt consolidation loan, the new account may lower the average age of your credit history, which could also cause a temporary dip. However, the impact on your credit generally won't be as prolonged, or as severe, as the impact caused by filing for bankruptcy.

"On the contrary, consolidating your debt has the potential to increase your credit score, even if it causes a temporary dip," says Zarrad. "It will dip from closing your extraneous lines of credit, but making your regular scheduled payments will help get your score back on track."

Find out how much relief debt consolidation could provide today

The level of relief

When you take out a debt consolidation loan, you typically benefit from a lower interest rate and more manageable payments. A debt consolidation program typically results in a lower interest rate and payment term negotiations with your lenders. As a result, debt consolidation loans and programs may result in paying less in interest and getting out of debt faster than you would by making only the minimum payments. However, neither debt consolidation option results in your debts being discharged. 

On the other hand, bankruptcy may provide more relief. If you file for Chapter 7 bankruptcy, the court may discharge all of your eligible debts. (Some tax debt, debt as a result of malice and divorce settlements are typically not eligible for discharge.) If you file for Chapter 13 bankruptcy, the court will typically discharge a portion of your debt while restructuring the rest to make it more affordable based on your budget. In either case, bankruptcy usually offers a higher level of relief than debt consolidation. 

The cost

If you opt for a debt consolidation loan, the costs involved are typically the lender fees and interest you pay in the process. These costs vary by lender and are based on your credit score and borrowing profile. 

Debt consolidation programs, or debt management programs, usually charge a setup fee followed by a monthly fee for their services. For example, In Charge Debt Solutions charges an initial setup fee of up to $75 on average (depending on the state) and an average monthly fee of $33 for debt management services. 

The filing fee for bankruptcy typically starts at $338, according to Bankrate. Attorney fees will usually add between $700 to $2,000 or more to your total cost, but those fees can be higher. 

The process

The debt consolidation loan process is usually simple. All you need to do is apply, and get approved, for the debt consolidation loan and use the proceeds of the loan to pay off your credit card debts. You then make your regular payments on your loan according to the terms you agreed to. 

The debt consolidation program process is also relatively simple. It typically starts with a short conversation with a debt relief expert about your debts, your budget and what you can afford to pay each month. The debt relief service does most of the work from there, negotiating with your lenders and creating an effective payment plan. You then send in your monthly payments as agreed until your debts are paid in full. 

Bankruptcy, on the other hand, typically involves quite a bit of paperwork and regular communication with an attorney. Though most filers won't have to appear before a judge, they are typically required to attend a meeting with their creditors. And, if you file Chapter 13 bankruptcy, you'll probably be required to make payments toward your debt according to the court's instructions.  

The bottom line

Credit card debt consolidation and bankruptcy are two very different debt relief options. Credit card debt consolidation may have a minimal impact on credit scores, typically offers relief from high interest rates and is relatively inexpensive. Although bankruptcy usually offers a higher level of relief, the credit impact can be significant and the process required is typically more involved. Moreover, bankruptcy may cost thousands of dollars in court costs and attorney fees. 

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