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Debt Consolidation vs. Bankruptcy: How To Choose

Understand when debt consolidation is an option and when to consider bankruptcy instead.

Author
By Lindsay Frankel
Lindsay Frankel

Written by

Lindsay Frankel

Writer

Lindsay Frankel has been covering personal finance for six years, with particular expertise in loans, insurance, and real estate. She’s written hundreds of articles across a range of well-known outlets, including LendingTree, Investopedia, SFGate, and more. Outside of writing, she enjoys playing music and exploring nature with her rescue dog, Lucy.

Edited by Jared Hughes

Written by

Jared Hughes

Editor

Jared Hughes is a personal loan editor for Credible and Fox Money, and has been producing digital content for more than six years.

Updated April 19, 2024

Editorial disclosure: Please note that this article contains affiliate links. If you click through and purchase a product from one of our advertising or lending partners, we may earn a commission. The amount of commissions do not affect our editors' opinions or recommendations. Credible Operations, Inc. NMLS # 1681276, is referred to here as “Credible.” Please read our affiliate disclosure for more information.

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Debt consolidation and bankruptcy are two options for getting out of debt, but they can have drastically consequences for your financial future. Debt consolidation involves paying off your debts with a new loan, with the goal of getting a lower annual percentage rate (APR), and may actually improve your credit over time.

Bankruptcy allows you to wipe away certain debts. But it’s considered a last-resort option since it can have a catastrophic impact on your credit.

Debt consolidation vs. bankruptcy: What to know

Debt consolidation is an option for repaying your combined debts at a lower interest rate. Unlike bankruptcy, it doesn’t reduce what you owe. But it can reduce the interest you’re required to pay, which can help you get out of debt faster or make payments more affordable. If you consolidate your debt with a personal loan, the process can be quick and easy.

However, if you’re overwhelmed with debt and can’t afford the monthly payments on a new loan, or if you have poor credit, debt consolidation may not be an option for you. You may want to consider a debt management plan through a credit counselor, for example, or a more extreme solution.

Bankruptcy is a legal process that may require you to hire an attorney and pay upfront filing fees. The total cost to file can range from $400 to $3,000, according to nonprofit Upsolve, which offers a free online bankruptcy filing tool for eligible debtors. Bankruptcy has the potential to erase most of your debts. But it’s important to understand that bankruptcy can significantly lower your credit score, which can make it difficult to buy a home or get an auto loan for up to 10 years.

 

Debt consolidation
Bankruptcy
Type of process
  • Financial
  • Legal
Overall cost
  • Depends on interest rate
  • A few hundred to a few thousand dollars (depending on which chapter you file for and attorney fees)
Repayment time
  • 1 to 7 years (depending on lender)
  • Chapter 7: 4 to 6 months from filing to discharge
  • Chapter 13: 3 to 5 years of repayment until discharge
Credit impact
  • Little to no initial impact
  • Might improve credit in the future if you make on-time payments
  • Major negative impact
  • Stays on credit report for 7 to 13 years (depending on which chapter you file for)
Effect on debt payments
  • Leaves with you a single payment
  • Could eliminate some or all of your monthly payments
Wipes out debt?
  • No
  • Can discharge some or all debt

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How does debt consolidation work?

Debt consolidation involves combining your debts so that you only have one monthly payment. The process typically relies on low-interest financial products, like 0% introductory APR credit cards, home equity loans, or personal loans, to manage higher-interest existing debts, like credit card debt or payday loans.

For example, you might take out a personal loan and use the money to pay off your credit card debt. Instead of paying interest on your credit cards, the average interest rate on which was 21.59% as of February 2024, according to the Federal Reserve, you’d only have to worry about one monthly payment on your personal loan. Two-year personal loans had an average rate of 12.49% in February, according to the Fed, so using this strategy could mean paying less money in interest over time. With less to pay back, you can pay down your debt faster.

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Tip

If you have bad credit, you can still qualify for a consolidation loan, but a cosigner — someone with good credit who’ll make payments if you can’t — may help you get approved. Not all lenders allow cosigners, so compare them with that in mind.

Learn More: How Much Credit Card Debt Is Too Much?

Pros and cons of debt consolidation

Pros
Cons
  • Simplifies your financial obligations with one monthly payment
  • Allows you to pay less in interest
  • May improve your credit with on-time repayment
  • May have a fast and easy application process
  • Doesn’t require a legal process
  • Excellent credit needed to access the lowest rates and biggest savings
  • May come with upfront fees, like loan origination and balance transfer fees
  • May not be a solution for people who can’t afford the minimum monthly payment

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4.24.2

Credible rating

Fixed (APR)

6.99% - 25.49%

Loan Amounts

$5000 to $100000

Min. Credit Score

700

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3.93.9

Credible rating

Fixed (APR)

7.80% - 35.99%

Loan Amounts

$1000 to $50000

Min. Credit Score

620

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4.44.4

Credible rating

Fixed (APR)

-

Loan Amounts

$2500 to $40000

Min. Credit Score

660

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on Credible’s website

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4.54.5

Credible rating

Fixed (APR)

8.49% - 35.99%

Loan Amounts

$1000 to $50000

Min. Credit Score

600

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on Credible’s website

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44

Credible rating

Fixed (APR)

8.98% - 35.99%

Loan Amounts

$1000 to $40000

Min. Credit Score

660

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on Credible’s website

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4.94.9

Credible rating

Fixed (APR)

8.99% - 29.99%

Loan Amounts

$5000 to $100000

Min. Credit Score

Does not disclose

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44

Credible rating

Fixed (APR)

8.99% - 35.99%

Loan Amounts

$2000 to $50000

Min. Credit Score

600

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on Credible’s website

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3.93.9

Credible rating

Fixed (APR)

9.95% - 35.99%

Loan Amounts

$2000 to $35000

Min. Credit Score

550

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on Credible’s website

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4.34.3

Credible rating

Fixed (APR)

-

Loan Amounts

$5000 to $35000

Min. Credit Score

700

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on Credible’s website

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4.34.3

Credible rating

Fixed (APR)

11.69% - 35.99%

Loan Amounts

$1000 to $50000

Min. Credit Score

560

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on Credible’s website

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3.93.9

Credible rating

Fixed (APR)

11.72% - 17.99%

Loan Amounts

$3000 to $40000

Min. Credit Score

640

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on Credible’s website

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44

Credible rating

Fixed (APR)

-

Loan Amounts

$20000 to $200000

Min. Credit Score

660

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3.73.7

Credible rating

Fixed (APR)

14.30% - 35.99%

Loan Amounts

$3500 to $40000

Min. Credit Score

640

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on Credible’s website

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3.93.9

Credible rating

Fixed (APR)

18.00% - 35.99%

Loan Amounts

$1500 to $20000

Min. Credit Score

540

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on Credible’s website

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How does bankruptcy work?

Individuals generally have two options when it comes to filing for bankruptcy:

  • Chapter 7 bankruptcy: To qualify for Chapter 7 bankruptcy, you’ll need to meet certain income limits. Once you file, collection attempts should come to a halt. Your bankruptcy trustee will liquidate your nonexempt assets to pay your creditors. Any remaining debt is discharged, typically within 90 days of the first meeting with your creditors, which means you won’t be responsible for repayment.
  • Chapter 13 bankruptcy: You’re generally eligible for Chapter 13 bankruptcy if your unsecured debts are less than $2.75 million. Filing stops most collection attempts. Instead of offering immediate discharge, Chapter 13 bankruptcy allows you to protect your assets while entering into a repayment plan that lasts 3 to 5 years, depending on your income. Any remaining debts will be discharged once you reach the end of the repayment term.

Both types of bankruptcy can badly damage your credit. Chapter 13 bankruptcy remains on your credit report for seven years, while Chapter 7 bankruptcy stays on your report for up to 10 years. It's often best to hire an attorney to handle the bankruptcy process.

Pros and cons of bankruptcy

Pros
Cons
  • Can eliminate your debt in months
  • Filing stops creditors from attempting to collect
  • Assets like your car, home, and retirement accounts are often exempt
  • Allows you to get out of debt quickly
  • Non-exempt assets are not eligible for discharge
  • Severe, negative impact on your credit for up to 10 years
  • May require upfront filing fees and attorney fees that can cost hundreds or thousands

Other debt management options

Here are some other options to consider if debt consolidation or bankruptcy is not right for you.

  • Debt avalanche method: The debt avalanche method is a strategy for getting rid of debt that doesn’t require help from a lender. It involves making the minimum payments on all your debts and putting any extra money you have toward your highest-interest debt. Once it’s paid, you move on to the next debt with the highest interest rate. This method can save you the most in interest, but it can take a while.
  • Debt snowball method: The debt snowball method requires you to put any extra money toward your smallest debt, while continuing to make minimum payments on your other debts. Once your smallest debt is paid off, you’ll apply that monthly payment toward the next debt and so on, until it creates a snowball effect and your debt is paid off. This method is best for those who like to see quick progress.
  • Balance transfer card: This option transfers your balance from one credit card to another, often with a 0% introductory APR. You can make monthly payments toward paying off your debt, without interest accruing, which allows you to pay off debt faster. But keep in mind that once the promotional period ends, the standard APR will resume on any remaining balance.
  • Home equity loan or HELOC: With either of these options, you can borrow against the equity in your home. A home equity loan is an installment loan, while a home equity line of credit (HELOC) is a type of revolving credit. Both are secured by your home, so if you can’t make your payments, you could face foreclosure.
  • Credit counseling: A nonprofit credit counselor can help you with your budget and even enroll you in a debt management plan, which can reduce the interest and fees on your debts and lower your monthly payments. A debt management plan only requires one monthly payment to the credit counseling agency. Make sure to choose an approved agency.

Related:

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Warning

Debt settlement services advertise attempting to settle your debt for less than you owe, but this route is best avoided, as it can lead to collection attempts, damage to your credit score, and legal action being taken against you.

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Debt consolidation vs. bankruptcy FAQ

How does debt consolidation affect your credit score?

Debt consolidation may cause an initial dip in your credit score due to opening a new credit card or taking out a loan. However, as you make on-time payments and your debt balance decreases, your credit may improve due to lower credit utilization and a strong payment history.

How does bankruptcy affect your credit score?

Bankruptcy may negatively affect your credit score for up to 10 years, but the impact may become less severe over time. If you have excellent credit to begin with, your score will drop significantly after filing, by up to 240 points. If you already have poor credit, the impact of bankruptcy will be more moderate.

Can you get a debt consolidation loan with bad credit?

While you may be eligible for a personal loan even if you have bad credit, you’re unlikely to get a lower rate and save money on interest when paying off your current debts. If your new APR, which includes interest and fees, is the same or higher than you’re paying on your current debts, a debt consolidation loan won’t help you. Credit counseling could be more effective at helping you get out of debt.

How long does bankruptcy stay on your credit report?

Chapter 7 bankruptcy stays on your credit report for 10 years, while Chapter 13 bankruptcy falls off your report after seven years.

Meet the expert:
Lindsay Frankel
Lindsay Frankel

Lindsay Frankel has been covering personal finance for six years, with particular expertise in loans, insurance, and real estate. She’s written hundreds of articles across a range of well-known outlets, including LendingTree, Investopedia, SFGate, and more. Outside of writing, she enjoys playing music and exploring nature with her rescue dog, Lucy.