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Should I Consolidate my Debt or File for Bankruptcy?

Dan Steadman

Financial Advisor, MoneyBeagle

Things to Consider when Consolidating Debt or Filing for Bankruptcy

Should I Consolidate my Debt or File for Bankruptcy?

If you are struggling with your debt, you are not alone. Millions of people have found themselves overcome with debt and searching for a way out, and there are many debt management options available. If you are overwhelmed in debt, you may be considering debt consolidation vs bankruptcy. These are both options that can help and hurt your financial situation, so it is important to understand the details of both options before making your final decision and taking action to correct your financial situation.

Find a Reputable Credit Counselor

The first thing you should do is to contact a non-profit credit counseling agency. These organizations are staffed with professional counselors with specialized knowledge in analyzing personal finances, and they also have an understanding of the creditors and their willingness to negotiate a reduced payoff amount to avoid filing for bankruptcy. It is to the creditors benefit to work with you, because if your bankruptcy is approved, they will not receive anything.

A credit counseling service will help you analyze your debt and other expenses and help you determine if a debt consolidation loan or bankruptcy is right for your specific financial situation. Factors that may affect the determination are how deep you are in debt, what assets you own and the status of your accounts (for example, if they are in default or have been passed to a collections agency). The more severe cases of debt tend to lead to bankruptcy.

Debt Consolidation Loans

A debt consolidation loan comes with advantages and disadvantages, so it is important to be aware of both. A debt consolidation loan allows you to pay off your high interest debts while eliminating multiple monthly payments that come with having multiple credit card or other accounts. In addition, a debt consolidation loan will not cause as much damage to your credit score as a bankruptcy.

In fact, a debt consolidation loan may not significantly affect your credit score if you keep your credit card accounts open, because it will show that you have available credit. Keep in mind, though, that the purpose of a consolidation loan is to eliminate your debt, so you shouldn’t use any credit cards while you are repaying a debt consolidation loan. Your goal should be to live credit-card free for several years or more. Some people prefer to have one card for emergencies, which is fine as long as you can use it responsibly.

The only way a debt consolidation loan is beneficial to your finances is if you get a lower interest rate than what you are currently being charged on your credit card balances. This can be difficult if you have bad or poor credit, although it is possible. You should read the fine print of the loan agreement before you apply, so you can compare interest rates and compare lenders against each other to find the best deal. Debt consolidation loans also come with a loan fee, usually a percentage of the loan amount, so be sure to consider that as well.

When considering this type of loan, you should also compare the monthly loan payments to the current amount you are paying now. If the loan payments are not much less, then you may not want to pursue the loan. In addition, you should be aware of the loan term, because the longer the term, the more interest you will be charged over time.

Defaulting on a debt consolidation loan can cause severe damage to your finances and your credit score. You want to avoid this at all costs. In most cases, one late payment will increase the interest rate on the loan balance for the remainder of the loan term, and you will also be charged late fees.

Another aspect of debt consolidation loans to consider is that any amount you save due to this type of loan may be considered income by the IRS, so you will have to pay tax on it. If the credit card companies or creditors report a settled debt, then you must claim the amount saved as income.


There are two different types of bankruptcies: Chapter 7 and Chapter 13. If you own a business or have multiple assets other than what would be considered “normal”, such as a house or a car, then you may look into Chapter 13 bankruptcy. A Chapter 13 typically requires a supervised repayment plan and maintain some of your assets while eliminating some or most of your debt. Most people will file a Chapter 7 bankruptcy.

Chapter 7 Bankruptcy

If you own a large business or corporation, you will need to consider a Chapter 13 bankruptcy, which has different requirements than a Chapter 7. A Chapter 7 filing does not involve any business debts. If your income is less than the median income in your state and you have a significant amount of debt, then you have a good chance to be approved for a Chapter 7 bankruptcy. If your income is above the state median, you may still qualify, but the court will determine if you have enough disposable income to repay some or all of your debt on your own.

Disposable Income

Disposable income refers to the amount of money you have left after paying off certain monthly expenses. Only expenses deemed necessary by the court will qualify for inclusion when calculating your disposable income. If you have a significant amount of income left after deducting necessary expenses, then you should be able to pay more toward your debt, so you may not qualify for a Chapter 7 bankruptcy. Acceptable expenses include basic necessities such as food, utilities, housing and transportation.

The means test is examined by the court, but there are other factors they may consider, depending on the state you live in. Because the bankruptcy process is extremely difficulty, it is useful to seek the assistance of a credit counselor or a bankruptcy lawyer.

There are some debts that cannot be included in a Chapter 7 bankruptcy. For example, child support or alimony cannot be included. Any debt that was incurred due to criminal or malicious acts cannot be included and in a bankruptcy. If you have those types of debts, you may want to pursue an alternative option.

Advantages of Filing for Bankruptcy

When you file for bankruptcy, you are provided the protection of an automatic stay. An automatic stay legally prohibits creditors or collection agencies from contacting you in any way, including phone calls, lawsuits, wage garnishments, repossession and foreclosure. This can provide a relief to people who have been struggling with harassing phone calls from creditors or collections agencies.

If your Chapter 7 bankruptcy is discharged (or approved), you will have the chance to start over and rebuild your credit over time. Most of your debt will be eliminated, so you should be ready to manage your finances responsibly and live off your income alone. You should not be using credit cards at this time. In fact, you should be following a budget and putting money in a savings or emergency fund each month. A bankruptcy should not be taken lightly, so you should be serious about your commitment to live debt-free and to manage your spending habits.

Now that your debts are eliminated, you should have some extra money after paying your necessary expenses. If you don’t, you may want to consider increasing your income to avoid falling back into debt. If you haven’t already done so, you may want to examine your expenses to see where you can make cuts to reduce your overall costs. During the bankruptcy process, you should begin to develop a plan for your future.

Disadvantages of Filing for Bankruptcy

Filing for bankruptcy will lower your credit score and it will remain on your credit report for 7 to 10 years. If you are concerned about the effect on your credit score, you may want to consider other options to reduce or eliminate your debt. It is up to you to determine of the advantages outweigh the advantages.  For most people who qualify for a Chapter 7 bankruptcy, their credit has already been significantly damaged because of their extreme debt.

A Chapter 7 bankruptcy is a matter of public record, which can have negative effects. Some employers may not consider you as an applicant if they run a credit check, while others may terminate your employment if you work in a financial occupation or other industry that requires managing or handling finances. A bankruptcy may also affect your chances of getting approved for an apartment or a car loan, although it doesn’t necessarily mean you are automatically declined.

You may be required to give up some of your property if you file for a Chapter 7 bankruptcy, although you  may be able to keep some possession such as your house or car, it really depends on your situation and how much property or how many assets you have

Before you decide on a debt consolidation loan or a bankruptcy, be sure you know the details of each and how each would affect your finances and your credit score. If you cannot get a debt consolidation loan with a low interest rate, or if you can barely afford the monthly loan payments, you may want to consider filing for bankruptcy. It depends on the severity of your situation. Although it is a long process, it allows you to have a fresh start and rebuild your credit by managing your new financial situation responsibly.

Other Options to Consider

Debt consolidation loans and bankruptcies are not the only options for reducing or eliminating your debt. If your debts are in collections and you have defaulted on most of your accounts, then the two options discussed here may be right for you.  As mentioned previously, you should contact a credit counselor who can help you identify the right debt reduction or debt management plan for your specific financial situation.

Although all debt can feel overwhelming, it is important to assess your financial situation to determine the best path toward financial freedom. In some cases, you may be able to cut back on your expenses and increase your income so you can pay down your debt on your own. It may take some time, but you will avoid loan fees and interest rates and the stain of a bankruptcy on your credit report.

Debt Settlement Plans

With a debt settlement plan, you will use a debt settlement company who will negotiate with your creditors to reduce the balance on your accounts. The company can reduce your debt up to 50% in some cases, but you will also be charged negotiation fees which can add up to almost as much as they saved you in negotiations. You will make monthly payments to the debt settlement company, and they will save that money in an account and use it to pay off your creditors one by one. The disadvantage is that while you are accumulating your money, you continue to default on your payments, which will significantly damage your credit score.

Not only will you pay fees to the debt settlement company, but any debt they save you will be considered income to the IRS, so you will have to pay taxes on that amount. It is possible to get a debt settlement and still end up paying back the amount of your original debt or even more. The excessive fees and interest rates can add up quickly, so it is important to carefully consider if this is the best option for your financial situation.

Regardless of if you choose a debt consolidation loan, bankruptcy or another debt reduction option, be sure to understand what you are getting in to. It may sound great at first, but it can be an extremely painful process to some, so it is good to be prepared. You may have ups and downs as you go, but in the end, you will be free of debt, and there is no greater feeling than that.


If you're considering bankruptcy or consolidation, you probably have a range of different questions. While many of these questions will need to be directed to a lawyer or lender, you can still learn a lot by taking a look at some of our most commonly asked questions. Check out a full list of our FAQs below.

Bankruptcy Debt Clearance

If you have questions about bankruptcy debt clearance, below are the top questions we receive about clearance.

Does bankruptcy clear tax debt?

This will depend on the type of bankruptcy that you're declaring. For example, in some cases you can wipe away income tax debt with Chapter 7 bankruptcy. You can't clear other types of taxes such as payroll tax debt.

Does bankruptcy clear IRS debt?

Again, this will depend on the form of bankruptcy that you're looking to declare. Income tax debt can sometimes be wiped away using Chapter 7. Other forms of tax are typically not eligible for this form of removal.

Does bankruptcy clear child support debt?

No. The courts typically protect child support payments – you will still need to pay child support if you declare bankruptcy.

Which bankruptcy eliminates all debt?

No. It depends on the type of debt that you're working with and the type of bankruptcy that you declare. There are many debts that bankruptcy cannot clear.

Does bankruptcy clear medical debt?

Yes. In many instances, you can clear medical debt using bankruptcy. This is very fortunate considering how large medical debt burdens can be for American families.

Does bankruptcy clear state tax debt?

This will depend on a variety of factors including the type of bankruptcy, type of debt, and the state that you're declaring bankruptcy in. In short – some state taxes can be cleared if you meet certain conditions, while other cannot. Chapter 7 bankruptcy is typically the best type of bankruptcy for clearing tax debts.

Can IRS debt be discharged in bankruptcy?

This depends on the type of debt you have. If you file Chapter 7 bankruptcy, you have a high chance of being able to offload income tax debt if you meet certain conditions. Most other tax debts are not dischargeable.

What happens to debt in bankruptcy?

This depends on the type of debt. There are some debts that you cannot offload. While other debts will be discharged – you will no longer be responsible for paying the debt. Obviously, this comes at a massive cost – it will effectively destroy your credit rating and prevent you from borrowing for a considerable amount of time.

Student Loan Bankruptcy

If you have a student loan and you are considering filing for bankruptcy, you may have some questions. Below are our most common student loan bankruptcy questions.

Can I file bankruptcy on student loan debt?

Typically, you can't file bankruptcy on student loans – this is one of the many forms of debt that is very hard to discharge. This being said, it's not impossible. You just have to prove certain things – such as undue hardship.

How to file bankruptcy for student loan debt?

Filing bankruptcy for student loan debt is actually extremely complex. It’s one of the hardest forms of debt to discharge. To start the process, you should speak with a lawyer to discuss the options available.

Does filing bankruptcy clear student loan debt?

Not in all circumstances. Most of the time, student loan debt cannot be discharged – there are some situations where you may be able to discharge student loan debt, but speaking to a lawyer about this complex issue is your best option.

Credit Card Bankruptcy

If you have credit card debt that you're trying to get rid of, you may be considering filing bankruptcy. Below are common questions we receive about credit card debt and bankruptcy.

How to file bankruptcy on credit card debt?

Filing bankruptcy can be a complicated issue. If you want to file bankruptcy on credit card debt, it's often best to speak to an attorney to get the process started. You may want to consider looking consolidation as well: How does debt consolidation work pros and cons.

Can you file bankruptcy on credit card debt alone?

Typically, no – you have to tell the courts all of your current debts. Bankruptcy is meant as a last resort, so you typically have to file bankruptcy on all your debts.

How to get out of credit card debt without bankruptcy?

There are plenty of options to get out of credit debt without filing for bankruptcy. If you want to avoid continuing with your credit card debt levels, it's a good idea to consolidate credit debt or use debt settlement. Both of these options are much less serious than bankruptcy.

General Bankruptcy Information

If the above sections don't answer your questions, take a look at our other common FAQs in more detail below.

How much debt do you need to file bankruptcy?

There is no set amount that you need to file bankruptcy. Your eligibility will depend on your income, debt, and your ability to pay back your debt. The courts will decide this when they look at your case.

Can you file bankruptcy on IRS debt?

Yes – you can file bankruptcy on IRS debt – but not all forms of IRS debt are eligible. For example, payroll tax is typically not eligible, while income tax is. You will need to meet certain requirements for this to be valid.

What is consumer debt in bankruptcy?

Consumer debt is typically debt that is incurred for ‘personal, family, or household' reasons. For example, your credit card debt is typically considered consumer debt.

Can you file bankruptcy on debt consolidation?

Typically, you can file bankruptcy on debt consolidation. This is because most debt consolidation is just another form of unsecured loan – you use this loan to pay off your old unsecured debts, such as credit cards.

What is unsecured debt in bankruptcy?

Unsecured debt is debt that isn't tied to the value of collateral. For example, credit card debts and lines of credit are typically unsecured debts.

When you file bankruptcy what happens to your debt?

If you successfully file bankruptcy, your eligible debts will no longer be your responsibility in many cases. Some forms of bankruptcy will require you to pay back the money over a payment plan. In Chapter 7 bankruptcy, all eligible debts are normally discharged.

Can medical debt be discharged in bankruptcy?

Yes. Medical debt is typically unsecured debt, so in most cases it can be discharged in the same way that credit card debt is discharged.

What kind of debt does bankruptcy cover?

There are a wide range of debts covered by bankruptcy – the ones you can discharge will depend on your personal circumstances. In many cases, popular debts such as credit card debts, medical bills, accident claims, collection agency claims, utility bills, and more are all eligible.

Can you file bankruptcy on government debt?

It depends on the type of government debt. For example, income tax is a form of government debt that you can file bankruptcy on – if you meet specific requirements. On the other hand, there are plenty of government and tax debts that are not eligible for bankruptcy.

What debts are discharged in chapter 7 bankruptcy?

It depends on your particular bankruptcy – the courts will decide this. Typically, you can discharge credit card debt, utility bills, medical bills, auto claims, and more.

Should I file bankruptcy or debt settlement?

While debt settlement and bankruptcy are both serious issues, debt settlement is slightly less hard on your credit record. The decision to file bankruptcy of use debt settlement will depend on your personal financial circumstances.

How to eliminate debt without bankruptcy?

You have a lot of different options for eliminating debt without bankruptcy. You can consider debt consolidation, debt settlement, making a strict budget, and a range of other financial strategies. Bankruptcy should always be a last resort.

Do you have to pay taxes on discharged bankruptcy debt?

No. In most cases you will not have to pay taxes on the discharged debt that you used owe.

When you file bankruptcy who pays the debt?

In most cases, the lender has to incur the debt that you're declaring bankruptcy on. This is why it is so harmful to your credit score.

Does bankruptcy clear income tax debt?

Chapter 7 bankruptcy can clear income tax debt in certain circumstances – this is one of the only taxes that is eligible for bankruptcy.

Is it better to file for bankruptcy or debt consolidation?

In most cases, it's better to file for debt consolidation if you want to ensure that you don't completely destroy your credit score. This being said, the best option will depend entirely on your personal financial situation. If you are a member perhaps you can look into debt consolidation USAA offers.

What debt does bankruptcy not cover?

This depends on the type of bankruptcy and the conditions of your debt. For example, student debt is normally not covered, but it can be in certain circumstances. Most taxes (outside of income tax) are not covered either.

Is it better to file bankruptcy or pay off debt?

If you can pay off the debt, it's almost always better to do so. Filing for bankruptcy will destroy your credit rating and make it next to impossible to borrow money in the near future. You can use methods such as debt consolidation to help you pay off your current debt levels faster.

What is secured debt in bankruptcy?

Secured debt is any form of debt that is secured to collateral or an asset. For example, a mortgage is a secured debt because it is secured against the value of the home you have purchased with the borrowed money.

Is it better to pay my debt or file bankruptcy?

It's typically better to pay your debt – this is especially true if you believe you have a chance of paying it off. If you file for bankruptcy, you will destroy your credit score. Regardless, there are instances were bankruptcy is the better option – it depends on your personal situation.

Is debt settlement better than bankruptcy?

Debt settlement is bad for your credit score but it's not as devastating as bankruptcy. If you think you can pay off your debt via settlement, it's probably the better option. Bankruptcy is normally a last resort. Using a credit card payoff calculator can help you make this decision.

What bankruptcy chapter is used to reorganize debt?

When people talk about reorganizing debt via bankruptcy, they're normally referring to Chapter 13 bankruptcy. This form of bankruptcy is reserved for business use.

What is the debt to income ratio for bankruptcy?

Your debt to income ratio will be used as a factor in deciding if you're eligible to discharge your debt in bankruptcy. Debt to income ratio is typically all of your monthly debt obligations (car payments, credit card payments) in a ratio to your gross monthly income.

Does filing bankruptcy remove your entire debt obligation?

This depends on the type of bankruptcy and the type of debt. In many cases, Chapter 7 will remove your obligation for your entire debt. But some debts – such as child support – will not be discharged. Make sure you understand which debt obligations are covered by the form of bankruptcy that you're using.

What is the difference between bankruptcy and debt relief?

Bankruptcy is much worse for your credit score. Debt relief typically implies you're making an agreement with the lender on a reduced overall debt charge, whereas bankruptcy discharges the debt completely.

What is an accounts receivable debt bankruptcy?

This is a form of bankruptcy that allows a company to keep its accounts receivable after a bankruptcy.

Can debt collectors collect after filing bankruptcy?

In most cases, debt collectors cannot collect after filing bankruptcy. Most debt collector accounts are discharged during Chapter 7 bankruptcy. If the debt is not covered by bankruptcy, then the debt collector can still pursue your debt. Make sure you understand which debts are covered by your bankruptcy.

How to split bankruptcy debt in divorce?

Unfortunately, you don't typically have much say in the matter. The court will decide how to divide up the debt in the case of a divorce. This is part of normal divorce proceedings that will include the division of your assets and other debts.

Can I be sued for business debt after civil bankruptcy?

If the debt is eligible for discharge you typically cannot be sued for the debt. But some debts are not dischargeable and you can still be sued. It's best to talk to a lawyer if you have legal concerns from a debt while you're conducting a business bankruptcy.

Are spousal support obligations priority debts in bankruptcy?

Priority debts are forms of debts that cannot be discharged in bankruptcy. In most cases, you cannot discharge the alimony in bankruptcy – there are some ways around this, as well as some ways to change your alimony considering your circumstances have changed. It's best to consult with a lawyer about this issue. It's also essential to note that child support payments are not dischargeable.

What is recent debts for luxuries from bankruptcies?

This often refers to the use of credit cards or other forms of credit to purchase luxury goods before you declare bankruptcy. This is often thought of as fraud and can land you in some serious hot water.

Can you collect a nondischargeable debt after bankruptcy closes?

Yes. This form of debt is not covered by bankruptcy, which means that you cannot discharge it. Creditors can still attempt to collect this form of debt after your bankruptcy closes.

Does bankruptcy stop debt collectors?

Chapter 7 is capable of stopping most debt collectors, though you should note that it's not typically as simply as you may think. Some debt cannot be discharged – debt collectors can still retrieve these debts.

Does bankruptcy automatically accelerate the debt?

No. In many cases bankruptcy will not accelerate your debt. For example, Chapter 7 does not accelerate your mortgage loan.

How do you reaffirm a debt after bankruptcy?

You can make an agreement to reaffirm a debt after bankruptcy if you choose to do so. This being said, you typically don't need to pay your debts after Chapter 7 bankruptcy, so there's no real need to reaffirm your debts in normal circumstances.

Dan Steadman

Dan Steadman

Financial Advisor, MoneyBeagle

Dan is one of the top financial experts when it comes to debt consolidation. With more than 20 years of experience helping people tackle debt, he has a unique insight when it comes to solving debt-related problems. 

Dan got his start when he went to work for a bank after getting his Business Degree. He worked his way up and became a loan officer. This position gave him unique insights into the ways that financial products work and how people can utilize different financial products to improve their lives. He’s seen hundreds of success stories and just as many failures – so he knows what steps are most likely to help his readers.

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