Bankruptcy vs Debt Consolidation
The Difference Really Does Matter
We’ve all heard the drive-time radio ads for debt consolidation. The hook is always the same: “Avoid bankruptcy!!” Because these firms know that fear of bankruptcy is the most powerful tool they have. If only the audience knew how deceptive the sales pitch can be. My point here will be simple. “Avoiding bankruptcy” almost always actually makes those in debt worse off than going forward with bankruptcy.
What Debt Consolidation Can – and Cannot – Do.
The debt consolidation works like this. You pay – usually several thousands of dollars – to the consolidation company. Once their fee is paid in full, they start work. Their agents contact your creditors to negotiate a better deal for you. Sometimes, it works.
But often it doesn’t. Or at least not like you hoped. Creditors can’t be forced to take part. So they don’t have to put lawsuits and collection calls and letters on hold. If the creditor already has a judgment, they don’t have to stop garnishing your wages or bank accounts. They don’t have to stop reporting the debt as past due.
Drastically Different Approach. Drastically Different Outcome.
But bankruptcy doesn’t offer the creditors an option. They all participate. Creditors have to stop all collection actions once your attorney files your bankruptcy case. As a result, the bankruptcy stops all wage garnishments and bank levies. Creditors even have to halt and later change how they treat your debt on your credit report. You don’t have to negotiate. You don’t have to hope all the creditors go along with “the plan.” Certainty is 100%.
Debt consolidation is pretty unsatisfying even in a best case scenario. Let’s say your creditors agree to accept 10% of what they’re owed. Yay(?) But once you’ve finished paying that 10%, you get a big fat 1099-MISC for the other 90% as INCOME. That’s because the IRS calls it “cancellation of debt” income. And the creditors don’t purge your bad credit. Instead, they report it “paid as settled”, not paid as agreed.