Dealing with debt is frightening. It affects your future, your ability to buy a house or a car, and it can often feel like a shadow over your life.
You’re not alone–as of 2015, eight in ten Americans were in debt, usually because of a mortgage or student loan debt.
If you can handle your monthly payments, dealing with debt can seem easy. But if you can’t make your payments and start to fall behind, the consequences pile up fast.
If you’re drowning in debt, don’t worry. You have options available to you.
Maybe you’re considering debt relief vs bankruptcy and you don’t know which one is right for you. Here, we’re breaking down the difference, a few types of bankruptcy and debt relief, and which one is right depending on your situation.
What is Bankruptcy?
Let’s start with the basics.
Bankruptcy is a legal term for the process undergone by someone unable to repay their outstanding debts. This can refer to a person or to a business.
It’s a scary word for many people, but bankruptcy is designed as a way to help people get out from under substantial debt without giving their creditors a raw deal.
There are two main types of bankruptcy we’ll address here: chapter 7 bankruptcy and chapter 13 bankruptcy.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is the type of bankruptcy usually associated with a fresh start.
In these types of cases, the debtor gets certain debts wiped out without having to pay in a monthly repayment plan. This can include credit card debt, personal loans, and medical bills.
In exchange, the creditor agrees that the bankruptcy trustee overseeing the case can sell a nonexempt property, and the proceeds are distributed to creditors in a ranking system.
Note that the debtor won’t give up all of their assets. They’ll be able to keep certain things that will allow them to continue working an maintaining a home–common examples include clothes and a small amount of equity in a vehicle.
In fact, there are debtors who get to keep all of their property.
Note that certain kinds of debt cannot be dealt with under a chapter 7 bankruptcy. This includes:
- Student loan debt
- Domestic support obligations (i.e. child support)
- Income taxes incurred over the last three years
- Injury or wrongful death awards incurred while driving under the influence
However, individuals and businesses can both file for chapter 7 bankruptcy.
Chapter 13 Bankruptcy
Then, there’s chapter 13 bankruptcy.
Under this type of bankruptcy, debt is reorganized for high-earning individuals. You get to keep all of your assets, but you’ll have to pay your creditors the value of all your nonexempt assets as part of a three- to five-year payment plan.
To qualify for this type of bankruptcy, you need to have some sort of stable income source with which to repay your debts. You’ll negotiate a repayment plan with your creditors. The minimum repayment amount will vary based on how much you owe, how much you earn, and the value of your nonexempt property.
What is Debt Relief?
With all of that in mind, let’s talk about the other half of our equation: debt relief.
Debt relief, generally defined, is the reorganization of debt in any way, shape, or form to grant relief to the indebted party.
It can take a number of forms, but creditors are only willing to consider debt relief as an option if the consequences of default are so severe that debt mitigation is a better alternative for all involved.
On a large scale, a sovereign nation with large outstanding debt may negotiate with its creditors to restructure their debt and offer relief.
Note, however, that some creditors may hesitate to offer debt relief, because they may view it as encouraging fiscally reckless behavior in individuals with a known history of irresponsibility, which would leave the creditors saddled with a bailout in the hopes of receiving a payment that never arrives.
Consumer Credit Counseling
Consumer credit counseling is one of the more straightforward options with regards to debt relief. Many nonprofits offer this service in free 45-minute sessions.
Essentially, you would work with your credit counselor to figure out a payment plan structured in a way that’s manageable for you and tolerable for your creditors.
If, for example, you used a credit counseling agency to work out a debt management plan, you would send monthly payments to the agency which it would then distribute to your creditors.
Debt Consolidation Programs
Another option is debt consolidation, which is when you consolidate all of your debts into one manageable account.
You might be wondering: what good would it do to dump all your debts into one pot?
The big benefit is that it eliminates a list of high interest rates from various creditors and allows you to concentrate on one monthly payment. It does not, however, do anything to lower your overall balance.
Debt Relief vs Bankruptcy: the Differences
So, now that you know how debt relief and bankruptcy work, you’re probably getting a sense for the differences.
The biggest difference between the two is where you are in the process. In general, it’s a good idea to investigate debt relief options before you seriously consider filing for bankruptcy.
That’s because filing for bankruptcy has more long-term effects on your credit than seeking debt relief, which is why any decision regarding bankruptcy must be carefully considered.
To put it simply: if you’re dealing with financial hardship because you lost your job, bankruptcy may be your only available option. Debt relief is a good choice if you’re trying to minimize the ripple effect on your credit score.
More Debt Advice
Now that you understand debt relief vs bankruptcy, do you know which one is right for you?
If you’re still not sure, no worries. Getting out of debt is a complicated process. That’s why we’re here to help.
Check out our blog for more tips, ideas, and explanations to help you make sense of your situation, like this post on the pros and cons of debt consolidation.