If your monthly payments and expenses exceed your income, and you have cut back as much as you can (you’re eating a lot of peanut butter and ramen noodles), you’re ready for a serious debt reduction strategy. This may involve debt consolidation, debt settlement, debt management, or even bankruptcy.
Here are the pros and cons of two similar options–the Chapter 13 bankruptcy filing and the debt management plan.
Chapter 13 Bankruptcy and Debt Management Plans Are Similar
Both of these solutions involve making regular payments over a period lasting up to five years to a third party–either a bankruptcy trustee or a credit counseling service. Both result in consolidating your debt into one lower payment each month. However, one solution is set up within the court system and the other is not. Here’s a breakdown of each option, including pros and cons.
Debt Management Plan
Under a debt management plan, you make monthly payments to a counseling agency that pays your individual creditors. The agency may negotiate lower interest rates or payments with creditors, and your payments could be as much as 40% lower. All your credit cards are closed, and a debt consolidation loan may be part of the plan.
Although the debt management plan is reported to the credit bureaus, the plan may not affect your credit score if the counseling agency pays your debts on time.
Debt Management Pros
- Minimizes credit score damage
- You may pay less interest
- Your balances may be lowered
Debt Management Cons
- Agency fees may eat up savings
- Balance reductions are taxable
- There may be balances or balloon payments due at the end of the plan
- Debt consolidation loans may increase your chance of mortgage foreclosure
- The plan may be unaffordable
- Creditors are not required to participate
Chapter 13
Like a debt management plan, under Chapter 13 bankruptcy you pay a trustee each month who then pays your creditors. Creditors are required to participate, and must stop charging interest and taking collection actions. The court determines what your payments are after reasonable living expenses are allowed, and remaining balances are discharged once you complete the plan.
Chapter 13 Pros
- Debts like back taxes can be discharged as well as unsecured debts
- You don’t have to repay the balances in full
- Forgiven debt is not taxable
- Creditors don’t have the option of refusing to lower your interest rate or payment
- The plan is created by a judge or trustee to be affordable
- Dis-chargeable debts are wiped out once you complete the plan
Chapter 13 Cons
- Your credit score may drop significantly
- The filing is a matter of public record for ten years
- It may affect your ability to get jobs, insurance, or loans in the future
Regardless of which solution you choose, make sure the help you get is reputable–an attorney with years of bankruptcy experience and a great reputation is worth seeking out and paying for. A credit counseling service should charge reasonable fees, not require upfront money, and offer budgeting advice as well as debt management services. An option that works for many is to try credit counseling first and check out debt management–see if an affordable plan for decreasing debt is available. If not, you may need to consider bankruptcy.