Credit Counseling vs. Bankruptcy: Processes, Pros & Cons

Credit Counseling vs. Bankruptcy: Processes, Pros & Cons

Bankruptcy and credit counseling both can be used to fight crippling debt and often they work together to resolve your problems.

Credit counseling always precedes a bankruptcy filing and also is mandated if your debts are discharged by a judge after filing. Sometimes a session with a certified counselor can help you avoid the difficult process of going to court to have your debts discharged or reduced through bankruptcy. At the very least, a credit counseling session helps you understand your options and the consequences of filing for protection from creditors under federal bankruptcy law.

Anyone who has racked up big bills and has spent months dealing with calls, letters and other close encounters with debt collectors knows how tempting filing for bankruptcy seems. Under the two major personal bankruptcy statutes — Chapter 7 and Chapter 13 — debts are either wiped away or reduced to a manageable repayment plan.

But a lot of people don’t dwell on the impact a filing will have on finances for years to come. Your filing will be noted on your credit report for 7-10 years, depending on which form of bankruptcy you choose.

The Do-It-Yourself Debt Management Plan

So how does this process work? First, try resolving your debt issues yourself. Contact your creditors, explain your predicament, and see if they are willing to work out a repayment plan. If your creditors know that you really want to pay your debts but might opt to file bankruptcy if you can’t, they might be motivated to work with you. Do-it-yourself debt management is possible, but it can require several phone calls and good negotiation skills.

The Credit Counseling Process

If that doesn’t work, credit counseling is the next step. Look for a nonprofit service with a track record for helping the indebted work through problems. Make sure you use a nonprofit: There are some companies that are well-known because of advertising, but charge very high fees and might not solve your problem.

Reputable nonprofit credit counselors may be able to work out a debt management plan that will require you to make monthly payments, which will be redistributed to your creditors in a pre-approved manner. The debt management plan is based on reducing interest rates with your creditors to arrive at an affordable monthly payment. You will be asked to close all the credit card accounts you used to rack up the bills and focus on depositing money in the repayment account. The debt management plan usually takes 3–5 years to complete.

If your debts are unsecured, be careful about the solution you use to make payments. Some people take out second mortgages or equity lines of credit on their homes and use the proceeds to pay off other debts. But beware of paying off debts by using your home or property as collateral. If you fail to make payments, the lender can foreclose and you’ll lose your property.

Credit counselors will explain all the options in detail and offer advice. They’ll discuss the impact of repayment plans and bankruptcy, and how both can hurt your credit score.

The Bankruptcy Process

Bankruptcy — despite its pitfalls — is sometimes the best solution, especially if you can’t meet the terms of a repayment plan. It allows you to move on relatively quickly and build new assets more quickly that a long-term debt repayment plan. But your credit score will take a big hit the minute you file, and a Chapter 7 bankruptcy remains on your credit report for up to 10 years, complicating future borrowing and sometimes your ability to find a new job.

Federal law requires that you arrange a 60–90-minute credit-counseling-for-bankruptcy session with an organization certified under the U.S. Trustee Program. The session usually costs around $50, but is free if you can’t afford to pay. Once you complete the session, you’ll receive a court-approved certificate that will allow you to file for bankruptcy.

The counseling can be valuable in deciding what sort of bankruptcy petition to file. Chapter 7, also known as straight bankruptcy, requires that you sell all non-exempt assets. Exempt items include such things as cars, work-related tools and basic household furnishings. Chapter 13 bankruptcy allows you to keep property like a mortgaged house or a car, but requires that you make payments to creditors under a court-ordered plan that will last 3–5 years.

After you file a bankruptcy petition, the law requires that you take a debtor education course. This course covers budgeting and managing money, as well as the wise use of credit. It usually lasts about two hours, costs $50-$100 (though fees can be waived) and requires that you choose a counselor from a court-approved list.

During your initial session, the counselor should weigh the advantages and disadvantages of debt relief plans vs. bankruptcy. The second session (assuming you opt for bankruptcy) should provide information about handling the aftermath once your case is settled.

Credit Counseling vs. Bankruptcy

Comparing the pros and cons of credit counseling and bankruptcy can help you see which one may work best for your situation.

Credit Counseling Pro: Minimal Impact on Your Credit Score

Credit counseling and debt management plan enrollment won’t have a negative impact on your credit score the way bankruptcy will. You should be able to qualify for a mortgage while on a debt management program as well as finance an automobile at favorable interest rates, provided your credit score is high enough.

Credit Counseling Con: No Debt Forgiveness and Long Time Commitment

With a debt management program administered by a credit counseling company, you must commit 3–5 years of your life to repaying your credit card debt. While you may have lower interest rates, you won’t have debt forgiveness.

The bottom line is that both credit counseling and enrollment in a debt management program and bankruptcy are viable, legal debt relief strategies. Before choosing which path is best for you, do your research and pursue a preliminary, free credit counseling session.

Credit Counseling Pro: Learning to Manage Personal Finances

Some consumers have enough income to handle expenses, they just don’t manage their money properly. This is where credit counseling can make a difference. The counselors are certified in helping consumers understand how to create a monthly budget, where to appropriate money and how to rein in careless spending. This service is free at nonprofit credit counseling agencies.

Credit Counseling Con: Do Your Research

Before choosing an agency, check to be sure the counselors are certified by the National Foundation for Consumer Credit. NFCC counselors must serve as advocates for the consumer first. They should recommend a solution that is best for the individual’s interest, not the agency’s best interest. If you sign up for a debt management program, there is a registration fee and monthly maintenance fee, usually around $50. Be sure to check consumer reviews of the agency.

Bankruptcy Pro: Get out of Debt Faster, Without Debt Forgiveness

One of the advantages of a Chapter 7 bankruptcy is that you can start over quickly — sometimes in a matter of a few months — with a clean slate. Your debt is forgiven. Not everyone qualifies for Chapter 7 bankruptcy, but if you do, you can essentially have your debts wiped away and rebuild your finances with a debt-free start.

Bankruptcy Con: Catastrophic to Your Credit Score

Nothing affects your credit score worse than filing for bankruptcy. The bankruptcy will remain on your credit report for seven years and will affect your ability to borrow money on a credit card, for a mortgage, and to finance an automobile. If you do file, find out how to rebuild your credit after bankruptcy.

Bankruptcy Pro: Stop Debt Collection Harassment

One of the overlooked aspects of bankruptcy is an end to harassment from debt collection agencies. When you file for bankruptcy, you qualify for an “automatic stay” that prevents bill collectors from contacting you. The automatic stay also delays action on foreclosures, wage garnishing and repossessions as well as keeping your water, electricity and gas on.

Bankruptcy Con: Discharges Can Be Revoked

If you were dishonest in filing for bankruptcy – filed fraudulent papers or didn’t properly disclose all assets – a judge could revoke your discharge. It also could be revoked if you received an inheritance in the 180 days after filing for bankruptcy. If the discharge is revoked, you are liable for all discharged debts and may face criminal prosecution or be asked to forfeit assets.


Sources

NA. ND. Discharge in Bankruptcy – Bankruptcy Basics. Retrieved from https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/discharge-bankruptcy-bankruptcy-basics

NA. ND. A credit counseling session is easy as 1,2,3 … Retrieved from https://www.nfcc.org/how-counseling-works/what-to-expect/

NA. (2019, January 15) The Pros and Cons of Filing Bankruptcy. Retrieved from https://eligibility.com/bankruptcy/the-pros-and-cons-of-filing-bankruptcy

Turner, K. (2019, August 4) What are the Pros and Cons of Filing Chapter 7 Bankruptcy? Retrieved from https://upsolve.org/learn/pros-cons-filing-chapter-7-bankruptcy/

About the author

Joey Johnston has more than 30 years of experience as a journalist with the Tampa Tribune and St. Petersburg Times. He has won a dozen national writing awards and his work has appeared in the New York Times, Washington Post, Sports Illustrated and People Magazine. He started writing for InCharge Debt Solutions in 2016.