Bankruptcy vs. debt relief: Which is the best option for you?

The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.

“I just need to stick to a budget. I’ll just get a second (or third) job. I won’t answer the phone or open my mail to avoid creditors. I just need more time.”

It’s human nature to want to fix your problems by yourself, especially something as stigmatized as debt. But the truth is, if you’re in debt and facing severe consequences, outside help like bankruptcy or debt relief may be the best pathway to a fresh start.

Neither option is easy, and there will be consequences, but the credit repair professionals at Lexington Law Firm know that when it feels like you are hanging from the edge of a cliff, it’s okay to ask for help. It’s best to talk to a professional about your situation before making a life-altering decision such as bankruptcy or debt relief, but in the meantime, we’ve assembled the basics of each to help you better understand your options.

Table of contents:

• What is bankruptcy?
• Chapter 7 bankruptcy
• Chapter 13 bankruptcy
• Pros and cons of filing for bankruptcy
• When to consider bankruptcy
• What is debt relief?
• Debt relief options
• Pros and cons of debt relief programs
• When to consider debt relief
• Which is better: bankruptcy or debt relief?

Bankruptcy	Debt Relief
Discharges eligible debt to give debtor a new start	Reorganizes debt to make it easier for the debtor to repay
No credit score or income required to qualify (except in Chapter 13 bankruptcy)	Handled privately between debtor, creditors and possibly a third party Not all debts qualify
Handled in the legal system	Options based on a credit score

What is bankruptcy?

Bankruptcy is a type of debt settlement handled within the legal system. The goal is to balance relieving you of debt with providing your creditors with as much repayment as possible. Because bankruptcy is a legal proceeding, hiring a lawyer is highly recommended.

Generally, when you cannot pay your debts, you can file a bankruptcy petition in federal court. After the proceedings, all or some of your debts from before the petition was filed are discharged or eliminated.

Not all debts can be discharged through bankruptcy, however. If you have any of the following debts, bankruptcy will not discharge them:

• Tax or other government-related debt
• Child support
• Alimony
• Personal injury debt (e.g., debt owed to another party after a drunk driving accident for which you are responsible)

Once the petition is filed, creditors must cease all collection-related activity. Once the court issues the discharge order  you are no longer legally responsible for any discharged debts.  

There are multiple types of bankruptcy, all of which are named after the chapter of the Bankruptcy Code they refer to. The most common types of bankruptcy for individuals are Chapter 7 and Chapter 13.

Chapter 7 bankruptcy

You can file for Chapter 7 bankruptcy when you have few, if any, assets and your monthly income does not exceed your state’s median income. However, owning many assets does not disqualify you from Chapter 7, it just results in a larger liquidation of assets if they are not exempt.

In this type of bankruptcy, the court creates an estate consisting of all your assets, including collections, stocks, bonds, cash and investment funds. The court appoints a trustee, who is responsible for liquidating the nonexempt assets. The trustee then uses the money from the liquidation to pay off as much debt as possible.

A debtor filing for Chapter 7 bankruptcy is not guaranteed discharge of any or all debt. Discharge may not be granted if you:

• Do not provide required documentation
• Do not complete a financial management course
• Destroy any records relating to the proceedings, such as financial records
• Commit perjury during the proceedings
• Transfer or hide property in an attempt to keep it from creditors
• Violate a court order
• Fail to explain any financial losses

Chapter 13 bankruptcy

If you do not qualify for Chapter 7 bankruptcy, you may be able to file for Chapter 13 bankruptcy. Also known as “wage earner’s bankruptcy,” Chapter 13 bankruptcy allows you to create a debt repayment plan, paid in installments over three to five years while keeping your property.

In order to qualify for Chapter 13 bankruptcy,  your debts must be  less than $2.75 million. In all forms of bankruptcy, debts are divided into three types:

• Priority debts: Debts that cannot be discharged, like tax debts
• Secured debts: Debts with collateral
• Unsecured debts: Consumer debts without collateral, such as credit card or medical debt

After filing, you create a debt repayment plan that is submitted to the court for approval. In the plan, all disposable income must be put toward debt reduction payments, which must total:

• The entirety of priority debt
• Enough of the secured debt to cover the value of the collateral at the time the loan was issued. (For example, you typically must repay the car’s value at the time of its purchase, not its current, depreciated value. But there are some exceptions to this—for example, a recently purchased vehicle cannot be paid the value of the collateral, but must be paid the loan amount.)
• Some or all of the unsecured debt to an amount greater than what the creditor would receive in Chapter 7 bankruptcy.

Within thirty days of filing your plan, even before the judge approves the repayment plan, you pay a monthly payment to the trustee of the case, who then allocates the payments to the individual creditors. This payment can be made via payroll deduction or monthly payments for three to five years, depending on the terms set by the court. After the agreed-upon period, all remaining debt is discharged.

During the repayment period, you cannot acquire new debt without the trustee’s consent. This prevents you from being unable to meet the terms of the repayment plan.

Unlike Chapter 7, in Chapter 13 bankruptcy, you are entitled to be discharged of debt as long as you uphold the terms of the plan approved by the court. However, if at any time you miss any tax, child support or alimony payments during the course of the repayment plan, the bankruptcy case could  be dismissed.

In many cases, Chapter 13 bankruptcy is preferable to Chapter 7 since it allows you to keep your property as long as you do not miss any payments.

Pros and cons of filing for bankruptcy

Filing for Chapter 7 or Chapter 13 bankruptcy can be helpful in a few ways:

• Debtors can overcome default by discharging debt they’d never be able to repay otherwise.
• Unsecured debt is largely eliminated.
• Debtors are protected from legal judgment, such as lawsuits and garnishments, and creditor harassment during and after the proceeding.

The biggest con of filing for either Chapter 7 or Chapter 13 bankruptcy is the damage it can do to your credit. Depending on the type of bankruptcy you file, it may appear on your credit report for seven to 10 years. However, it’s important to remember that if you are in a situation where bankruptcy is a good option, your credit is probably already damaged. In the long run, bankruptcy—and the subsequent debt discharge—may actually benefit your score over time, especially if you take the appropriate steps to rebuild it.

Other cons to consider include:

• You may lose property seized as collateral if you file Chapter 7.
• Bankruptcy does not discharge all debts.
• There is a social stigma attached to filing for bankruptcy.
• Loans, mortgages, leases, credit cards and other new debt will be difficult to get while the bankruptcy filing is on your credit report.
• The debtor will have to pay legal fees for the bankruptcy filing. These fees must be paid up front unless you qualify for payment installments or waivers.
  • Fees for Chapter 7:
    • $245 case filing fee
    • $75 miscellaneous court administration fee
    • $15 trustee surcharge
  • Fees for Chapter 13:
    • $245 case filing fee
    • $75 miscellaneous court administration fee

When to consider bankruptcy

Bankruptcy is a serious legal process with long-term consequences and should not be taken lightly.

However, if you face severe financial consequences such as repossession and foreclosure, or you have to choose between making minimum payments and necessities like food and shelter, filing for bankruptcy may offer you a fresh start.

If you are considering bankruptcy, it’s important to consult a professional to ensure it’s the best option for your circumstances.

What is debt relief?

Debt relief is when you reorganize your unsecured debt to make repayment more manageable. This reorganization can include lower interest rates, some debt forgiveness, fewer or lower payments or extended loan terms.

Debt relief options

Debt relief comes in many forms, and you’ll want to speak with a professional before deciding which one is right for you.

One option is debt consolidation, or combining multiple debts into one. To consolidate your debt, you can do any of the following:

• Take out a personal loan from a financial institution. The financial institution will then pay off the balance of all your other loans, and you’ll pay them one monthly payment. Doing so often results in a lower monthly payment with lower interest rates.
• Transfer all your credit card debt to one credit card. Look for credit cards with low introductory rates or promotions and low balance transfer fees. Transfer all your credit card debt to that card and pay one lower monthly payment with a lower interest rate.
• Take out a home equity loan or home equity line of credit (HELOC). A home equity loan or a HELOC will allow you to use the equity you’ve built up in your home to pay off debt. In addition to lowering your monthly payment, the interest may be tax-deductible.

Debt consolidation may be challenging if you have bad credit, but it’s not impossible.

Other forms of debt relief include:

• Refinancing a single loan by negotiating new terms or paying it off with a new loan that has better terms (e.g., refinancing your mortgage)
• Seeking credit counseling from a professional who can help you create and stick with a budget to get out of debt on your own
• Enrolling in a debt management program (DMP) through a nonprofit to negotiate credit card debt to get lower payments or interest rates or even forgiveness of some fees
• Negotiating with your creditors to pay some of the principal in a lump sum in exchange for forgiveness of the rest of the debt
• Participating in a debt forgiveness program sponsored by your lender or the government

Pros and cons of debt relief programs

The biggest pro of debt relief programs is that you can resolve your debt without entering the legal system, as you do when you file bankruptcy.

Cons of debt relief programs include:

• You may need a decent credit score or be at a certain income level to qualify for loans or forgiveness.
• You may need to pay expensive fees.
• Your credit score may be adversely impacted.
• Some people and companies take advantage of people looking for debt relief. To avoid being scammed, only pursue debt relief programs through accredited organizations.
• Your debt may not qualify for relief.
• It may take longer to pay off your debt due to longer terms than you originally signed up for.

When to consider debt relief

The best time to consider debt relief is when you are just starting to struggle with your monthly payments. At this point, your credit health may still allow you to qualify for loans to help you consolidate your debt, and any associated fees will be manageable. Plus, you’ll be able to see results faster and avoid more serious problems later.

Which is better: bankruptcy or debt relief?

At their core, bankruptcy and debt relief both offer relief from your debt and may negatively impact your credit, at least for a time.

The biggest difference between the two is that bankruptcy is conducted through the legal system, while debt relief is handled privately between you, your creditors and a possible third party (like another financial institution or credit counseling organization). Also, debt relief does not guarantee your debt is discharged, and you may end up filing for bankruptcy in the future if the debt relief strategies you choose aren’t enough.

When you are trapped in the undertow of debt, it can be tempting to grab the first lifeline thrown your way. But when it comes to bankruptcy and debt relief, grabbing the wrong one can have lifelong consequences. For that reason, it’s impossible to say definitively whether bankruptcy or debt relief is better for your specific situation without consulting a professional.

Lexington Law Firm offers a variety of services to fit your personal finance needs, specifically when it comes to credit. Start with a free credit assessment to start your journey to better credit.

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