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Is Debt Consolidation Better than Bankruptcy?

When facing unmanageable debts, many people question whether bankruptcy or debt consolidation through a debt consolidation company would be their best solution.  In order to effectively weigh your options, you need to have a solid understanding of how debt consolidation really works.

When entering into a debt consolidation program, you are entering into a contract with a service that will negotiate with individual creditors in order to lower your payments to these creditors.  This is a benefit to you because through negotiation, you may now owe creditors a fraction of what you owed previously and the interest rate may also decrease.  Also you will be making one lump sum payment to this debt consolidation company and they will pay your individual creditors for you.  There is usually a monthly administrative fee for this service.

While this service may seem advantageous, there are several downfalls of which you should be aware.  These companies typically require you to stop making direct payments to creditors while sending them payments.  These payments are not distributed automatically.  They will not be sent out until you have made a certain amount of monthly payments to this company.  In the meantime, you are likely to be assessed late fees by your creditors and over the limit fees if you were already close to the maximum limit on your credit card.  If you had already stopped making payments prior to this point in time, you could even be sued by your creditors while you are waiting for the debt consolidation company to make payments on your bills.  Unlike with a bankruptcy filing, you are still legally obligated to pay these creditors so when payments are not made, they can receive judgments against you.

There are other disadvantages to using debt consolidation companies.  Although your credit card companies may agree to accept a lesser amount than what they are owed, the IRS may consider any amount of forgiven debt to be taxable income.  This could negatively impact you when it comes time to file your taxes.  This is not the case in a bankruptcy filing where the debts.  The debts are discharged with no tax implications.

Also, debt consolidation companies work under the assumption that after your necessary household bills are paid, there should be a certain amount of disposable income.  In many cases that is simply not the case and people are actually living paycheck to paycheck.  In these cases you may be stuck in a consolidation program making payments you simply can’t afford.