Debt Management vs Bankruptcy

When faced with overwhelming debt, many people think bankruptcy is their only way out, but there’s another option you may not have heard about. Debt management is a debt relief alternative to those considering bankruptcy.

Understanding the differences between the two options can help you make an informed decision about which path best suits your financial situation.

What Is a Debt Management Plan?

A debt management plan (DMP) is a repayment program designed to help individuals pay off their credit card debt. It’s offered by nonprofit credit counseling agencies like InCharge.

A DMP simplifies your bills by consolidating your credit card payments into a single fixed amount each month. You make one monthly payment to a credit counseling agency like InCharge, and they take care of making monthly payments to your creditors.

Here’s how a debt management plan works:

1. Credit Counseling: It begins with a 20-30 minute call with a certified credit counselor trained in budgeting, credit, debt management and more. They’re required to act in your best interest, assess your situation and determine whether a DMP or another debt relief option is the best fit for you.
2. Payment Plan Setup: The credit counseling agency communicates with creditors to create a repayment plan with lower interest rates and to waive certain fees.
3. One Monthly Payment: Instead of tracking and paying multiple bills, you can make a single fixed monthly payment to the credit counseling agency, which then distributes the funds to your creditors.
4. Debt Payoff: A debt management plan typically takes 3-5 years to complete, depending on your financial circumstances. With a DMP, you will pay off debt faster, save money on interest, and improve your financial standing.

Pros of Debt Management

Avoids Legal Proceedings: Debt management programs prevent the need for legal action or court involvement, offering a smoother path to debt resolution than bankruptcy.

Preserves Credit Scores: By staying current on payments, participants in DMPs can maintain better credit scores compared to filing for bankruptcy.

Lower Interest Rates: Credit counseling agencies negotiate with creditors to reduce interest rates, making monthly payments more affordable.

Single Monthly Payment: Instead of juggling multiple creditors, participants make one consolidated monthly payment to the credit counseling agency, which then distributes the funds to creditors.

Debt-Free in 3-5 Years: Most DMPs are structured to be completed within a three-to-five-year timeframe.

No Credit Requirement: Because the program is set up as a repayment plan and not a loan, there is no new credit. This means there is no credit requirement either.

Teaches Financial Skills: Participants gain valuable budgeting and money management skills, empowering them to manage their finances independently in the future.

Cons of Debt Management

3-to-5 Year Commitment: Most DMPs are designed to be completed within a three-to-five-year timeframe, requiring participants to commit for the duration.

Full Repayment: Participants are required to repay their debts in full, ensuring that all balances are paid off by the end of the program.

Account Closure: Credit card accounts must be closed during the program, limiting access to future credit until the debt is paid off. Most agencies do allow for one credit card to remain open for emergencies.

What Is Bankruptcy?

Bankruptcy is a legal process designed to provide debt relief for individuals who are unable to repay their debts. Chapter 7 bankruptcy and Chapter 13 bankruptcy are the two typical types of personal.

Chapter 13 bankruptcy: This type of bankruptcy has more in common with a debt management plan than it does chapter 7 bankruptcy. In this version of bankruptcy, the court orders a repayment plan that lasts 3-5 years. It allows individuals to keep their assets while making reduced debt payments and it remains on credit reports for seven years.

Chapter 7 bankruptcy: Also known as liquidation bankruptcy, this is what people typically think of when they hear the term bankruptcy. It eliminates most unsecured debts, but it requires selling non-exempt assets. It does major damage to your credit score and will stay on your credit report for 10 years.

Pros of Chapter 13 Bankruptcy

• Debt Repayment Plan: Allows individuals to create a manageable repayment plan to pay off debt over 3-5 years.
• Avoids Foreclosure: Chapter 13 can help homeowners avoid foreclosure by allowing them to catch up on missed mortgage payments over time.
• Keeps Assets: Unlike Chapter 7, Chapter 13 typically allows debtors to keep their assets, such as their home and car, as long as they continue making payments.
• Protection from Creditors: Creditors are prohibited from continuing collection actions, including lawsuits and wage garnishments, during the repayment plan.

Cons of Chapter 13 Bankruptcy

• Lengthy Process: The repayment plan lasts 3-5 years, which can be a long commitment for individuals looking to resolve their financial issues quickly.
• Impact on Credit Score: While less severe than Chapter 7, Chapter 13 will still negatively affect your credit score and remain on your credit report for up to 7 years.
• Income Requirement: To qualify, individuals must have a stable income to afford the repayment plan, which may be difficult for some.
• Limits on Debt: There are limits on how much unsecured and secured debt you can have to qualify for Chapter 13.

Pros of Chapter 7 Bankruptcy

• Quick Debt Discharge: Chapter 7 is typically a quicker process, often taking only 3-6 months, allowing individuals to eliminate most unsecured debts.
• No Repayment Plan: Unlike Chapter 13 and debt management, Chapter 7 doesn’t require a repayment plan, meaning you’re not obligated to make payments over several years.
• Eliminates Unsecured Debts: Most unsecured debts, such as credit card balances, medical bills, and personal loans, can be completely discharged.
• Asset Exemptions: Many personal assets are exempt from liquidation, including certain equity in your home, car, and retirement accounts, depending on state laws.

Cons of Chapter 7 Bankruptcy

• Loss of Non-Exempt Assets: Some assets that are not exempt may be liquidated by the bankruptcy trustee to pay creditors.
• Impact on Credit Score: Chapter 7 has a significant negative impact on your credit score and remains on your credit report for up to 10 years.
• Means Test Requirement: Individuals with high income or valuable assets may not qualify for Chapter 7, as there are means tests to determine eligibility.
• Certain Debts Are Not Discharged: Certain debts, including student loans (except in cases of undue hardship), child support, alimony, and some tax debts, cannot be discharged in Chapter 7.
• No Foreclosure Protection: If you are behind on mortgage or car payments, Chapter 7 does not offer the same protection as Chapter 13 against foreclosure or repossession.

Choosing the Right Path

If you are struggling with debt, a credit counseling session can help you explore your options. A free consultation can provide insight into whether a debt management plan can help you regain control of your finances or if bankruptcy is the more viable solution for your situation.

Debt relief is possible, and taking the time to weigh your options will ensure you choose the best path forward for long-term financial stability.