Credit Counseling Vs. Bankruptcy

According to the U.S. Census, American consumers are $2.6 trillion in debt, collectively. This amount equates to approximately $8,500 per citizen. Mismanagement of debt can lead to severe financial problems and budgeting issues, often making it difficult for families to make ends meet. Credit counseling and bankruptcy are two common solutions for debt problems. Knowing the facts about each can help you determine which is right for you.

Credit Counseling

Consumer credit counseling aims to educate debtors about credit and help them manage their finances, usually through a debt-management plan. Credit counseling agencies act as negotiators on your behalf, working to reduce interest rates and ease repayment terms with your creditors. Credit counseling is best for consumers with a large amount of unsecured debt, such as credit cards or unsecured loans. Credit counselors cannot handle mortgages and auto loans.

Monthly payments are made directly to the agency and it disburses a predetermined amount to your creditors each month. Most credit counseling agencies charge a small monthly fee for their services.

Credit counseling has come under fire from the Federal Trade Commission (FTC) of late. A number of questionable agencies involved in shady tactics have created a bad reputation for the service. Exercise caution when choosing a credit counselor; check the Resources section (below) for FTC-approved counselors.

Bankruptcy

Bankruptcy comes in several different forms: Chapter 7, Chapter 11 and Chapter 13. Chapter 7 bankruptcy is a liquidation of your assets and a discharge of your debts. Chapter 7 is the quickest bankruptcy available for consumers, with an average completion time of less than a year. The downside to Chapter 7 is that you may lose a number of your assets, as they are sold to pay back a portion of your creditors.

Chapter 11 bankruptcy is primarily filed by corporations, although technically consumers can file, too. Chapter 11 bankruptcy is for debtors with more than $250,000 in debt and is more of a restructuring than a liquidation, combining elements of Chapter 7 and 13.

Your creditors will favor Chapter 13 bankruptcy. A large portion of your debts are repaid through the courts and disbursed to your creditors. The benefit of Chapter 13 over Chapter 7 is that you retain all of your assets, providing that you stick with the program. Credit counseling has much more in common with Chapter 13 than it does with Chapter 7.

The Bottom Line

What is best for you depends on your situation. There are pros and cons to bankruptcy and credit counseling. If you favor a quick exit from your debt with little regard to personal assets, Chapter 7 bankruptcy may be right for you. If you don't mind a lengthy program and want to retain your assets, Chapter 13 bankruptcy or credit counseling are good alternatives.