Debt is like a self-perpetuating crime empowered by time travel. This is especially true if you have unmanageable debt. Assume a large debt today and you’re robbing your future self of desperately needed money. You might pay off a fraction of the debt, still be broke, and then need to borrow more money. Too many Americans generate income via self-perpetuating debt-cycles. Burning the candle at both ends burns up the wick too. At some point you may need to consider bankruptcy or debt consolidation to climb out of a debt quagmire.
How can debt get so out of control to the point freelance or legal intermediaries must be brought in to solve it?
You can’t keep generating more debt if you can’t pay off any of the current debt you owe.
Bankruptcy or debt consolidation could be the answer.
Each solution has a price.
First, we must understand how debt quagmires happen in the first place.
And, we need a clearer understanding of how bankruptcy and debt consolidation processes work.
Bankruptcy or Debt Consolidation – The Small Picture
There are many reasons why debt quagmires happen, but I have two examples.
Those are the allure of the American identity as consumer and the pandemic decimating the finances of households and small businesses alike.
Americans want to be, “consumers,” instead of fiscally responsible, which requires sacrifice.
Who wants to practice responsible personal finance, or sacrifice, when there are things to buy? (Beside, your future self a month from now can sacrifice).
About 80% of Americans waste $7,400 annually by overspending on consumerism, not comparison shopping, and impulse buying.
We’re taught to be consumers from birth. It’s how the American government funds its coffers.
Over 70% of the government’s federal budget is bankrolled by American consumerism. The government needs you to buy things so it has money to function.
Mindless consumerism is only part of the problem.
American households and small businesses already struggling with debt and budgeting were financially knocked out by the pandemic.
The typical American household is burdened with over $90,500 in debts.
20% of new businesses fail within the first year of opening. Now consider that 100,000 businesses have already closed permanently due to the pandemic. If a vaccine isn’t found soon, over 7.5 million businesses could close permanently.
Over 60 million people have applied for unemployment insurance since March 2020. Tens of millions of Americans will be evicted in the coming months and years.
You watch the news just like me. There are many reasons why you may need to utilize bankruptcy or debt consolidation.
Bankruptcy or debt consolidation should be last resort options. But for many Americans, those may be the only two options currently available.
Debt Relief Basics
Utilizing bankruptcy or debt consolidation isn’t a magic get-out-of-debt-jail-free card.
Declaring bankruptcy is a multi-year legal process. Every penny, dollar, and assets of value you own will be legally inventoried and monetized to convince creditors to negotiate what you owe.
You may be able to keep some assets during the bankruptcy process, but it is not a given.
Debt consolidation combines all of your outstanding debts into one loan with a new interest rate.
Your debts are basically turned into a personal loan in consolidation. This consolidated debt loan is wholly controlled by a financial service or a bank who negotiates bill payment in your stead.
The debt relief process that works for you depends on how involved in the process you want to be.
Neither one is easy.
Filing for Bankruptcy
If you choose bankruptcy in the, “bankruptcy or debt consolidation,” choice, you must start by filing legal papers.
You can file for Chapter 7 or Chapter 13 bankruptcy. The type of bankruptcy you file for depends on your financial status and the availability of assets that can be liquidated.
These are legal processes where your money and assets are inventoried, liquidated, reorganized, and divided up between all concerned creditors.
You will be assigned a court-appointed bankruptcy administrator. They will oversee your finances and negotiate with your creditors in your stead but also in guided coordination with you.
Your bankruptcy administrator legally negotiates with your creditors to get them to accept a negotiated value of your liquidated assets. This value may be lower than what you actually owe but is better than creditors getting nothing. Once paid off, your debts are discharged, or legally settled.
Basic Differences Between Chapter 7 and Chapter 13
Chapter 7 bankruptcy is for financially disadvantaged individuals who can’t pay their debts. It is more of a legal debt forgiveness plan.
Certain assets and property could be liquidated to satisfy your creditors, if you have any. I most cases, legal exemptions may allow you to keep some assets.
Outstanding debts in a Chapter 7 filing can be discharged within 5 months.
Chapter 13 bankruptcy is reserved for individuals with more appreciable finances and property. Your bankruptcy administrator assesses your finances and create a debt forgiveness and repayment plan with your creditors.
Depending on your administrator’s assessment, you could keep your home and some assets. It could take up to 5 years for all of your debts to be discharged after declaring Chapter 13.
Please understand, this is the basic explanation of a bankruptcy filing. It is a legally complicated and emotionally exhausting process. For example, bankruptcy declarations stay on credit histories for a decade.
It is a simple process.
Bankruptcy should only be initiated with the guidance of a legal professional. Don’t try it on your own.
Debt Consolidation
So, you’ve chosen debt consolidation in the, “bankruptcy or debt consolidation debate?”
Risky choice.
You may have seen debt consolidation services offered on late night TV commercials. This is not a service where you need to file legal papers to initiate. You could call an 800 number from a sketchy infomercial to start the process, but it isn’t recommended.
Debt consolidation services are offered by individuals, finance firms, and banks.
A debt consolidation service converts a multitude of smaller debts into one large personal loan to pay off your creditors. Debt consolidators negotiate with your creditors in your stead.
You don’t play a role in the debt consolidation process itself. After your debts are converted into a loan, your job is to make payments on time and in full.
There are many ways where you could end up paying more money than you originally owed with debt consolidation.
Your debt consolidation service charges application, origination, service, and commission fees. You must pay this on top of the consolidate loan.
Your length of payments could last a handful of years. Even with a low or high interest rate, you may pay more than what you originally owe.
The lower your credit score, then the higher your interest rate will be.
You may need to collateralize property you could potentially lose if you don’t keep up with your loan payments.
If you default on payments or generate more debt, then you will be in an even worse situation than before you started.
Bankruptcy or Debt Consolidation?
If you are in a debt quagmire, avail yourself of the counsel of a financial advisor or lawyer.
As to the question of bankruptcy or debt consolidation, both processes require sacrifices. They also incur financial consequences which can last for years.
The only upside to filing for bankruptcy is that your debts become legally settled once paid off.
Plus, watching everything you own being inventoried and liquidated to settle your ridiculously monstrous debts is an emotionally scarring but educational experience.
If that doesn’t teach you about the perils of unmanageable debt, nothing will.
Debt consolidation only works if your financial judgment on debt generation has matured.
Your debt consolidation service oversees the process and then tasks you with paying back the consolidated loan.
On your own.
If paying debts on your own wasn’t an issue, you wouldn’t need debt consolidation.
There is no bankruptcy-like administrator to oversee the process.
You can’t continue a self-perpetuating debt cycle mentality with debt consolidation. Otherwise, your debt problems will only magnify exponentially and grotesquely.
I can’t tell you which process is better. “Need,” may be a better word than, “better.”
If you are in a serious debt quagmire, you may need to legally declare bankruptcy to effectively get out of a debt hole.
With debt consolidation, you will be all on your own without the benefits of legal filings and documentation.
Choose wisely.
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Allen Francis was an academic advisor, librarian, and college adjunct for many years with no money, no financial literacy, and no responsibility when he had money. To him, the phrase “personal finance,” contains the power that anyone has to grow their own wealth. Allen is an advocate of best personal financial practices including focusing on your needs instead of your wants, asking for help when you need it, saving and investing in your own small business.