Getting Out of Debt: Consolidation Loans and Bankruptcy

No matter where you are in life, financial problems can strike. The loss of a job, an unexpected illness, or other problems can mean financial hardship - and eventual ruin if you don't take control of the situation. With that in mind, there are several ways to handle debt reduction. Consolidation loans and bankruptcy are two of those ways.

Consolidation Loans for Debt Reduction

One option you have when you're struggling with debt is to lower your interest or payments by consolidating your debt through a second mortgage or a home equity line of credit. You need to be aware that you will be transferring unsecured debt to secured debt. These loans require your equity as collateral, so if you can't make the payments you could lose your house.

You have to qualify for these loans like any other loan, so you need a low debt to income ratio. Like most people with debt issues, you may have a high debt to income ratio because of hardships that involve a loss or reduction in your salary.

The costs of these consolidation loans can add up. In addition to interest on the loan, you pay "points." Typically, one point is equal to one percent of the amount borrowed. Still, these loans may provide tax advantages not available with other types of credit.

Bankruptcy for Debt Reduction

Another option, which should only be used as a last resort, is bankruptcy. Under US bankruptcy law, Chapter 7 basically wipes away your debt. But you can only keep certain assets. Exempt property may include automobiles, work-related tools, and basic household furnishings. You may have to surrender some of your property to be sold by a court-appointed official or turned over to your creditors. You can file for a Chapter 7 only once every six years.

Chapter 13 bankruptcy is for people with a steady income. Under chapter 13 you can keep all of your property but you also keep your debt. With chapter 13 bankruptcy, you follow a court approved repayment plan that lets you use your future income to pay off your debt in a three-to-five-year period. When you complete the plan, you receive a discharge of your debts.

Both Chapter 7 and Chapter 13 must be filed in federal bankruptcy court. With court and attorney fees, bankruptcies usually cost between $700.00 and $2000.00 dollars, depending on how complicated they are. Both types of bankruptcy may get rid of unsecured debts and stop foreclosures, repossessions, garnishments, utility shut-offs, and debt collection activities. Both provide exemptions which allow you to keep certain assets, although exemption amounts vary.

Personal bankruptcy usually does not erase fines, taxes, alimony, child support, and student loans. And in a chapter 7 bankruptcy you are not usually allowed to keep property your creditor has a mortgage or lien on, unless you renegotiate terms with your creditor to keep something specific, such as a car that you're paying on.

Both types of bankruptcy stay on your credit report from seven to ten years and they do have a negative affect on your credit, although the extent of that effect is usually related to how good your credit score was before the bankruptcy. For example, if the bankruptcy is the only negative thing on your credit, it will be less damaging than if it is coupled with late payments, judgments, and write-offs from creditors who couldn't get paid.

Debt Reduction Sources

U. S. Courts. "Bankruptcy Basics." The Federal Judiciary