Debt Consolidation or Bankruptcy


Should I File a Bankruptcy in Phoenix?

Are you searching for bankruptcy alternatives? Do you want to get out of debt, but avoid filing bankruptcy? Does the thought of filing a Chapter 13 or a Chapter 7 bankruptcy case frighten you?  The stigma from chapter 7 alone will make you consider options.

Before you decide how to get out of debt, you need to consider all options.  There are bankruptcy and non-bankruptcy options available.  In some cases, a non-bankruptcy option might be best for you. However, filing for bankruptcy needs to be considered.  Each person is different.  Read what is right for you below.

There are three bankruptcy alternatives that many people consider.  We encourage you to review these debt-eliminating alternatives to bankruptcy.  Contact our Phoenix bankruptcy law firm for more information about ways you can get rid of debt quickly.  After you learn about the benefits of filing a Chapter 7 or Chapter 13 bankruptcy, compare the to the bankruptcy alternatives.

  1. Debt Consolidation Companies

Arizona debt consolidation companies promise to help you get out of debt without bankruptcy.  The do this by combining your debts into one payment each month that you can afford. The debt consolidation companies promise that the payment will be lower than the combined payments of all your debt.  This way it is easier for you to get out of debt and have more money each month to pay your living expenses.  Some debt consolidation companies even claim they can work with your creditors.  They try to lower interest rates and reduce the amount you owe on each debt.

These claims seem fantastic, but can debt consolidation companies deliver on those promises. How does a debt consolidation help you get rid of debt?

How Debt Consolidation Companies Work

Debt consolidation companies work with your creditors to negotiate lower payments and lower interest rates.  However, there are some things that a company may not tell you about consolidating your debt into one monthly payment:

  • Your creditors are not required to work with you or the debt consolidation company. Therefore, you may have some creditors who do not agree to negotiate better terms. You will be responsible for paying these debts in addition to the debt consolidation payment each month.
  • Even if a creditor agrees to the terms proposed by the company, that creditor can continue debt collection efforts. A creditor can choose to pursue a debt collection lawsuit, foreclosure, or repossession at any time, even if you are current on your payments to the company.

How Debt Consolidation Affects my Credit

  • Creditors continue to report negative information to credit reporting agencies, such as late payments, over-the-limit balances, etc. In many cases, the company may pay creditors late each month or pay less than the required minimum monthly payment. This information continues to lower a credit score. Therefore, your credit score continues to be negatively impacted even though you are making monthly payments to a debt consolidation company.

How Much Does Debt Consolidation Cost

  • The company uses the money you pay to it each month to pay your creditors that agree to negotiate with the company. However, a portion of your payment is retained by the consolidation company as a fee. Fees for services can be substantial. Therefore, you are paying very little each month toward reducing your debt.
  • To achieve a lower monthly payment, the company usually negotiates a longer repayment term with the creditor. Even if the interest rate is reduced slightly, you will pay more money back to the creditor.  Lower payments for a longer time result in more money for the creditor.
  • If a creditor “forgives” a portion of your debt, the creditor must report the information to the Internal Revenue Service. The amount of debt written off by the company might be considered income for tax purposes.  This will be seen as income by the IRS.  It will increase the amount of taxes you owe at the end of the year.

How Debt Consolidation Companies Compare to Bankruptcy

How do debt consolidation companies compare to bankruptcy? With a Chapter 7 bankruptcy, you do not pay anything to your creditors for unsecured debts. Those debts are discharged through your bankruptcy filing.  You are no longer legally liable for the debts. The money is not considered income for tax purposes.  Better yet, each creditor must work within the bankruptcy court.  There is no more asking permission.  Creditors cannot “choose” whether they participate in your bankruptcy case. Furthermore, creditors must cease all collection efforts immediately upon the filing of a bankruptcy petition.

If you file Chapter 13 bankruptcy, you only repay a portion of the amount you owe to each unsecured creditor. Also, you do not pay any interest on the unsecured debts.  The remaining balance is discharged at the end of your bankruptcy plan.  Filing bankruptcy can lower your credit score temporarily; however, filing bankruptcy can actually improve credit scores.  Your credit will recover much quicker than if you work with a debt consolidation company.

  1. Debt Consolidation Loans

You may be considering a debt consolidation loan to get out of debt. However, as with a company to consolidate debts, there are a few things you should carefully consider before taking out a debt consolidation loan.

For instance, if you are using a debt consolidation loan to pay off debts such as credit cards, medical debts, and personal loans, you are changing unsecured debts into a secured debt. Most lenders demand collateral for a loan. Therefore, you are taking an unnecessary risk with your home, vehicle, or other asset. Unsecured creditors typically cannot take your home or vehicle. However, if you default on the debt consolidation loan, the lender can repossess the collateral or file a foreclosure against your home.

Another consideration you must factor into your decision is whether you can afford the monthly payment. If you are struggling to pay your debts now, how will you be able to afford to pay the loan payment each month? Because you are taking out a loan, you are not getting rid of your debts. You are simply trading one creditor for another creditor.

How Debt Consolidation Loans Compare to Bankruptcy

By filing for bankruptcy relief, you eliminate your debts while protecting your assets. In most Chapter 7 cases filed in Phoenix, the debtors get rid of most, if not all, of their debts while keeping all their property. A Chapter 7 bankruptcy gives you a fresh start. You get rid of unsecured debts within four to six months.  After bankruptcy, you can begin rebuilding your finances and working toward a strong financial future.  Compare this to risking your home and paying thousands of dollars in interest payments.

  1. Using Retirement Savings to Get Out of Debt

The third bankruptcy alternative many people choose is using retirement funds to pay off debts.  You are gambling with your future when you choose this option.  If you cannot replace the funds in your retirement account, you may not have enough money to pay your living expenses during retirement. You could find yourself struggling to make ends meet, selling assets to pay bills, and facing bankruptcy during retirement.  There are two different ways to access retirement accounts.  You can take a distribution, or take a loan.

IRA or 401(k) distribution to avoid bankruptcy

If you take a distribution, there is a penalty.  The IRS will want 20% of the amount taken as a penalty.  Additionally, you will have to declare this as income.  A distribution from your IRA will also complicate bankruptcy.  The distribution will have to be counted as income.  That will count against your means test calculation.  This might mean you do not qualify for a chapter 7 bankruptcy.  The worst part is that any qualified retirement money is protected by bankruptcy exemptions.  This means that nobody can take your retirement except you.  Taking retirement to pay debt to avoid bankruptcy is a bad deal.

IRA or 401(k) loan to avoid bankruptcy

If you consider a loan against your retirement money, be careful of the interest.  You are dealing with people who manage money for a living.  They are not giving you any deals on interest.  Then the kicker, if you cannot pay it back, it becomes a distribution.

In a bankruptcy case, most retirement funds are protected from the court and your creditors. You can eliminate debts while keeping the money in your retirement accounts safe. Before you begin dipping into your retirement savings to pay debts, you need to consult with a Phoenix bankruptcy attorney to discuss bankruptcy options. Once you withdraw money from your retirement account, you lose the protection provided by bankruptcy exemptions for retirement accounts.

Filing Bankruptcy in Phoenix, Arizona

Our Phoenix bankruptcy lawyers can help you weigh your bankruptcy alternatives and bankruptcy options to determine the best way to get out of debt. Depending on your unique financial situation, filing a Chapter 7 or Chapter 13 case might be the best way for you to eliminate debt, protect your property, and begin to improve your credit score.

Contact our office now to request your free bankruptcy consultation. It does not cost you anything to learn about bankruptcy and how filing bankruptcy can help you get back on track to achieve financial well-being.