Which debt solution is best for you?
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A financial crisis doesn’t crop up overnight. Usually, it’s a process over time that sees you go from financially healthy down the slippery slope into unmanageable debt. Sometimes it’s prolonged job loss that impairs your finances. For others, it might be divorce or a medical crisis that causes problems. No matter what happened, when you find yourself drowning in debt, you need a solution.
In some cases, consumers may be able to get back on track by tightening the belt and devoting all spare money to bills. But sometimes you need an outside intervention to help. Three of the most common forms of debt relief are a debt management plan, debt consolidation, and bankruptcy. Here is a look at some of the reasons why bankruptcy might be better for you than the other options.
Debt Consolidation vs. Debt Management Plan (DMP)
The phrase “debt consolidation” is often used inaccurately. Many times, people use that term when people actually mean a debt management plan. Debt consolidation is radically different from a debt management plan. Here are the differences between the two.
Debt consolidation is a way to tackle debt by taking out a loan to pay off all the other debts. You won’t have less debt, regarding dollars and cents, than you did before. However, depending on the loan terms, you may pay less in interest and have longer to catch up on what you owe.
For example, say you owe several creditors for debt including credit cards, medical bills, and a furniture loan totaling $65,000. You would get a loan for that amount and use it to pay off the other bills so that you still owe the same amount but to one creditor.
In some cases, people use their home equity line of credit (HELOC) to try this approach while others go specifically shopping for a debt consolidation loan. The loans are usually at more reasonable rates than credit card interest, and you’ll have several years to pay.
Debt Management Plan
A debt management plan (DMP) isn’t about borrowing money to pay off your debts. Instead, it’s a repayment plan negotiated by a third party with the hope that the creditor will reduce your balances, lower your interest rates, or both.
With a DMP, you usually make monthly payments to the third party that set up your plan, and they turn around and distribute the funds to your creditors. You still owe the same number of creditors but might get longer to pay your debt and (hopefully) better terms.
On top of paying your creditors, third-party firms that set up and manage DMPs charge a fee for the process. Not all debt management plan firms are reputable and not all negotiate more favorable terms than what you already have or could secure for yourself.
Bankruptcy vs. Debt Consolidation or DMP
The third option to deal with debt is bankruptcy and is drastically different from either debt consolidation or a DMP. With Chapter 7 bankruptcy, you can discharge unsecured debt like credit cards and medical bills within just a few months. With Chapter 13 bankruptcy, your lawyer sets up a repayment plan to catch up on debt over time.
With Chapter 7, you pay drastically less on what you owe. With Chapter 13, you should pay less on your unsecured balances than you currently owe, sometimes as low as pennies on the dollar. In most cases, you’ll pay less on your debt balances with bankruptcy than either debt consolidation or DMP.
Here are some other considerations:
DMP worsens your credit score
For your creditors to be open to a debt management plan that lowers the interest rate or balance owed, you must be delinquent on your finance agreement. The way for that to happen is to stop paying the bills, which is what DMP agencies tell you to do.
As soon as you start skipping payments, your credit score will drop. Bankruptcy also drops your credit score when you first file, but you can begin rebuilding your credit once you have your discharge. Post-bankruptcy filers can improve their score faster than those on DMP.
DMP can cause increased income taxes
With a DMP, the agency tries to talk your creditors into lowering the debt that you owe. For instance, if you owe $5,000 on a credit card and the DMP manager gets the company to accept $4,000, that means $1k of your debt was forgiven.
At the end of the year, the creditor will likely issue a 1099-C listing that $1k as taxable income. That means you’ll pay more in taxes. Every creditor that accepts less money than you owe will likely send a 1099 that hikes your taxable income.
In contrast, debt discharged in Chapter 7 or Chapter 13 bankruptcy carries no income tax consequences. If you have $50k of debt discharged in bankruptcy, there will be no added income taxes but with a DMP, that would all be taxable income. The savings can be significant.
Debt consolidation and DMP takes years
Paying off a debt consolidation loan or a debt management plan can take years. With the former, your credit score might stay in decent shape, but with a DMP, your score will likely remain problematic. Chapter 13 bankruptcy can take three to five years. Chapter 7, though, can be done in just a few months and you can be out of debt and back on the path to financial recovery.
Debt consolidation and DMP may not lessen your debt
With Chapter 7 bankruptcy, you pay filing and lawyer fees but, in exchange, you get to unload lots of debt. Chapter 13 bankruptcy also comes with plan fees, court fees, and lawyer costs, but you usually get a break on how much of your unsecured debt you pay so you should come out ahead.
With a DMP, you’ll pay less on your debt but how much less is never a guarantee. There are also plan fees and depending on how much these are, it might eliminate any savings. With debt consolidation, you’ll pay the same amount of principal, but perhaps less in interest.
Before you decide to go through with a DMP or debt consolidation, it may be wise to meet with a bankruptcy lawyer for a free consultation to find out your options so you can make a well-informed decision that’s best for your financial future.
To find out more about the benefits of North Carolina bankruptcy, contact the Law Offices of John T. Orcutt. Read client reviews to see what to expect and then call 1-888-234-4181 to set up a free initial appointment at one of our locations in Raleigh, Durham, Fayetteville, Wilson, Greensboro, Garner or Wilmington.