Do You Need Debt Consolidation Before A Chapter 13 Bankruptcy?

Law Blog

If you're falling further and further behind on your bills each month, you may be contemplating bankruptcy as an option to get caught up and gain some breathing room. For many who earn too much to qualify for a Chapter 7 bankruptcy, debt consolidation or a Chapter 13 repayment plan may seem like the only viable options. But should you pursue these options at the same time, or should you seek bankruptcy only after a debt consolidation plan has failed? Learn more about the similarities and differences between debt consolidation and Chapter 13 bankruptcy to determine which option may be right for you.

What Are The Differences Between Debt Consolidation and Bankruptcy? 

Debt consolidation is designed to streamline both the number of payments you're required to make each month and the interest rates charged by each of your creditors. In a debt consolidation plan, you may be required to refinance multiple high-interest payments (like credit cards) into one lower-interest payment. Doing this can improve cash flow, especially if your net pay tends to fluctuate, and get your payments down to a more manageable level.

Chapter 13 bankruptcy operates in a similar, but more formal, fashion. In a Chapter 13 bankruptcy plan, you'll be required to declare all debts you plan to subject to bankruptcy, as well as your monthly gross income. The bankruptcy trustee will then devise a payment plan for your creditors that will pay off all secured debts within a certain time frame (generally three to five years) and leave you with enough monthly funds left over to pay for food, transportation, and other necessary expenses.

The main differences between debt consolidation and bankruptcy involve the formality of the plan. If you "fail" your debt consolidation plan, your credit may take a hit, but you have some freedom to start a new consolidation journey or pursue one of your bankruptcy options. If you fail a Chapter 13 bankruptcy plan, your ability to file another Chapter 13 (or a Chapter 7) in the near future may be limited, leaving you without many other avenues for debt relief.

When Should You Seek Chapter 13 Bankruptcy? 

In many situations, a Chapter 13 bankruptcy can provide the structure you need to manage a debt repayment plan. Debt consolidation is often fairly open-ended, and without a specific goal in mind (other than reducing your monthly obligations), you may find yourself falling behind. Taking up to a decade to repay each of your debts can mean paying significantly more in interest compared to the negotiated Chapter 13 rates and maximum five-year repayment plan.

And for those who are in their forties or fifties and need to catch up on lagging retirement contributions, debt consolidation payments may not leave enough discretionary monthly income to make these contributions, whereas a Chapter 13 bankruptcy may be able to provide for them as part of your holistic financial plan. Maintaining healthy retirement contributions even through a debt repayment plan can be the key to financial health in retirement, providing these assets with plenty of time to grow. 

On the other hand, if you're still not sure about committing to a Chapter 13 bankruptcy, it can be worthwhile to explore your various debt consolidation options before filing for bankruptcy protection. Once you enter a Chapter 13 plan, you'll be restricted from taking out new credit accounts (other than those authorized by the bankruptcy trustee) and your credit score may take a hit as well. (Fortunately, by the time you successfully exit your Chapter 13 plan, you'll have a long enough history of on-time payments to have reestablished a stronger credit history.)

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Business Law Basics: What Small Business Owners Need to Know

When I started my first small business, I had no idea how much I really didn’t know. I was fully prepared to deal with customers, sell product and even handle complaints and returns. What I wasn’t aware of was that there is so much more to it. I was lacking the legal expertise to protect the company and myself. I wanted others to benefit from my experience, mistakes and lessons learned, so I started this blog. From employment law to the legal business contracts you’ll have to sign when you form partnerships, business law is complex. I hope that the information here will help you to be better prepared when you start your business so that you’ll know when you need to call an attorney and when you can handle things yourself.