Is Loan Consolidation Better Than Chapter 7?
Loan consolidation or “Debt Consolidation”, is when a debtor combines their existing debt into one loan. Typically, filing a Chapter 7 bankruptcy will yield a much better result for the debtor and at a fraction of the price of loan consolidation. This is true even of an Emergency Bankruptcy filing.
A loan consolidation makes it easier for the debtor by allowing them to pay one creditor instead of numerous creditors. This typically results in a lower monthly payment due from the debtor. The loan consolidation company negotiates a lower balance on your debt for you, and in exchange you make your payments on an agreed upon schedule. When you have made your last payment, you will have a zero balance on each debt.
Pitfalls Of Loan Consolidation
Taxation On Forgiveness Of Debt— You will achieve dramatically different results regarding taxation, depending upon whether you choose loan consolidation or Chapter 7. In many instances, the lowered balance on your debt is considered forgiveness of debt. For example, if you owe $10,000 on a credit card and the loan consolidation company negotiates the balance to $7,500, you may have $2,500 of forgiveness of debt. The federal government considers this to be income. Come tax time, you will most likely receive a notice of $2,500 of income related to forgiveness of debt. You will then owe the taxes on that $2,500 just as if you had earned it as an employee. This comes as a surprise to many debtors and can undo the benefits of the negotiated debt. This is similar to the treatment of forgiven debt in a foreclosure outside of bankruptcy.
Default Penalties— The contract you sign with a loan consolidation company will be lengthy and complicated. Typically, it will include hefty penalties for failing to make your payment on time. In many cases, even one missed payment can result in you losing the benefits of the loan consolidation.
Exorbitant Fees— The fees charged by loan consolidation companies are a new element of your debt. Identifying the exact fees can be challenging due to the complexity of the contract you sign. In worst case scenarios, you may be sending more than 10% of your monthly payment to the loan consolidation company as a fee for managing your debt.
No Protection Against Creditors— Unlike Chapter 7 bankruptcy, you may find a creditor fails to cancel your debt in exchange for the payments you make through loan consolidation. You will also find the debt consolidation company often has no answer as to how to resolve this situation. You may end up arguing with a large lending institution about the balance on your debt. Without an attorney, this can be a tough fight often won by the creditor.
The Chapter 7 Bankruptcy Difference
One difference between loan consolidation or Chapter 7, is that in most cases, Chapter 7 bankruptcy involves a flat fee. As a result, you immediately know the total amount of money you are paying in order to receive a discharge of your debt. In most cases, the Chapter 7 bankruptcy fee you incur to receive a discharge of debt will be thousands of dollars less than the amount you would spend in a loan consolidation program.
Chapter 7 Time frame
While most debt consolidation programs will have a duration of 36 months or longer, your Chapter 7 bankruptcy will typically start and finish within 120 days. We provide clients with an estimated timeline for Chapter 7 when representation begins. During that time frame, you will typically only be required to attend one hearing called a 341 Meeting. Your attorney will attend that meeting with you.
Tax Implications In Chapter 7
One of the most meaningful differences between Chapter 7 and debt consolidation, is with regard to tax implications. In Chapter 7, you receive a full discharge of the debt in question. Additionally, federal bankruptcy law dictates that you will not owe any taxes on the discharge of that debt. This is a meaningful difference when compared to the tax consequences that can result from forgiveness of debt in debt consolidation, as discussed above.
Chapter 7 And Your Credit Score
You should anticipate your credit score will drop more as a result of your Chapter 7 than as compared to debt consolidation. This drop in credit score is minimized if your credit coming into debt consolidation and Chapter 7 is already less than perfect. On an equally important note, improving your credit score after bankruptcy is faster and easier than you might think. The primary reason for this is that the filing of a Chapter 7 dramatically decreases your debt. Your credit score is determined by many factors. One of those is your debt to income ratio. When your debt decreases and your income stays the same—as it does when you file Chapter 7—the result is a better debt to income ratio for your credit score. We have written on an article about Chapter 7 and your credit score, which may be helpful.
Chapter 7 And Protection Against Creditors
One amazing and powerful benefit of filing Chapter 7 is the Automatic Stay. The Automatic Stay goes into effect the moment you file your bankruptcy, and it prevents creditors from taking action to pursue collection of their debt. This means foreclosure proceedings come to a halt, as do court cases, phone calls, and letters from creditors.
The rights of creditors in Chapter 7 are dictated by the federal bankruptcy code. Unless you have too many assets or too much income for Chapter 7, there is virtually nothing your creditors can do to prevent a successful Chapter 7 filing. Your Charlotte bankruptcy lawyer will make sure to review your case with you from these perspectives, well before filing.
Speak With A Charlotte Bankruptcy Lawyer Today
If you are considering filing bankruptcy, it’s important that you speak with a Charlotte bankruptcy attorney. The call is free and you will come away with a much better understanding of your options. You can reach us at 704.749.7747 or click to request a FREE CASE EVALUATION, and we will be in touch shortly.
If this article regarding loan consolidation or Chapter 7 was helpful, you may find other helpful articles on our Bankruptcy Blog. Thank you for visiting the website—we hope it has been helpful.