Difference Between Debt Consolidation & Bankruptcy

You may be looking for ways out if you have a lot of debt you can't afford. You have several debt relief options available, including debt settlement and bankruptcy. Many consumers view debt consolidation as a form of debt relief; however, debt consolidation is simply replacing old debt with new rather than helping get rid of debt.

How Debt Works

A debt is money you owe to another person or entity. Any time you borrow money you incur a debt. Car loans, credit card balances, personal loans, mortgage loans, medical bills, unpaid taxes and unpaid utilities are all types of debts. To get rid of debt, you can either repay it, ask the creditor to forgive it or file bankruptcy.

Debt Forgiveness

A creditor may choose to forgive some of the debt you owe, whether it's because you settled with the creditor and paid a smaller amount or because a mortgage lender foreclosed on your house and forgave a deficiency balance. If a creditor forgives debt, you usually must pay income taxes on that amount as if you had received it as income. Debt settlement and forgiveness is not debt consolidation.

Bankruptcy

A bankruptcy is a federal court case in which you ask the federal government to discharge your liability on certain debts and reorganize other debts. If you obtain a bankruptcy discharge, the discharged debts still exist, but your legal obligation to repay them is gone. A bankruptcy can wipe out your liability on credit card debt, medical bills, certain utilities, personal loans and certain income tax debt. You can also surrender a house or a car in bankruptcy and walk away owing nothing.

Debt Consolidation

To consolidate several debts into one, you must borrow enough money to pay off the smaller debts. You will then owe one large debt to one creditor. Debt consolidation can be beneficial if the interest rate on your new, large loan is better than the interest rates on your smaller debts; however, unlike bankruptcy, debt consolidation does not get rid of debt. It simply changes your debts into a different debt.