Credit counseling vs. Chapter 13 bankruptcy: Which is right for you?

If you find yourself in over your head in debt it might feel like there’s no chance of relief, but you do have options to manage your debt. In fact, there are many ways to take control of your finances and get back to a healthy situation. Here we will explore two of the options for people who find themselves in debt: credit counseling and chapter 13 bankruptcy.

What is credit counseling?

If you’re feeling overwhelmed about managing your debts, you might benefit from the guidance provided by credit counseling. Credit counseling organizations help people learn to manage their money and develop healthy, attainable budgets. They also offer access to free educational materials and classes.

Look for credit counseling agencies whose counselors are certified in understanding budgeting, debt management, and consumer credit. Credit counselors look at your entire financial situation with the goal of developing a plan that fits your needs and addresses your debt and money problems.

Most of these agencies are nonprofit, but that doesn’t mean they’re automatically trustworthy. Check for agencies that are recommended by the National Foundation for Credit Counseling or the Financial Counseling Association of America. Your local bank or credit union should also have a list of trusted credit counseling agencies if you need a place to start. Universities, military bases and housing authorities also may be able to point you in the right direction.

Setting up a debt management plan

In some cases, a credit counselor may suggest setting up a debt management plan (DMP). In a DMP, the credit counseling organization takes a very hands-on approach to help you get your debt under control. The credit counselor will negotiate with your creditors on a payment plan that reduces your monthly payments through lower interest rates and reduced or eliminated late fees and penalties.

Each month you will make one payment to an account held by the credit counseling agency and they will use that money to pay your creditors. A DMP can be used for unsecured debt— essentially debts like credit card debt or medical bills that are not tied to a specific asset like your home.

You’ll want to make sure to follow up with your creditors to confirm the details of the debt management plan. A DMP might take as long as three to five years to complete and if you miss a payment, you could lose any of the negotiated benefits.

As long as you and the credit counseling agency make the payments on time, a DMP should not negatively impact your credit score although it will be noted on your report.

While you’re under a DMP, you probably won’t be able to apply for new credit. Your counseling agency may even ask you not to use any credit at all, although most agencies will allow you to keep one credit account open. So make sure you you are okay being mostly credit-free for several years.

What is a Chapter 13 bankruptcy?

Bankruptcy may seem like a drastic step, but in some cases it may make the most sense for your financial situation.

There are three main types of bankruptcy: Chapter 11 (typically for businesses), Chapter 7 (a liquidation bankruptcy where you must meet income limits) and Chapter 13 bankruptcy (sometimes called a wage earner’s plan).

A Chapter 13 bankruptcy is for people who may make too much money to qualify for a Chapter 7 bankruptcy and also who want more protection against losing their home or car. A Chapter 13 bankruptcy requires people to pay back some or all their debt through a repayment plan. The plan can last either three or five years. Some unsecured debt like credit card debt and medical bills can be discharged, meaning they won’t have to be paid.

Chapter 13 can be a complicated process and it’s strongly recommended that you hire a lawyer to handle the process. You’ll have to submit a repayment plan to the court and then you will be monitored on your repayment progress throughout the length of terms of the plan. Like with a DMP, if you miss even just one payment, your plan is canceled.

Chapter 13 bankruptcies can be expensive, costing as much as $3,000 or more. However, you can roll your attorney fees into your repayment plan. A Chapter 13 bankruptcy will hurt your credit score and it will stay on your credit report for seven years.

How to choose

If you’re looking to choose between a debt management plan or Chapter 13 bankruptcy, the size of your income and the size of your debts may play a role. With a DMP, your debts don’t disappear, although you’ll end up paying less than you otherwise would due to reduced interest rates and fees. With Chapter 13 bankruptcy, some of your unsecured debts, like credit card debt, will be discharged.

If you’re on the verge of losing your house or car you might consider Chapter 13 bankruptcy to help protect you against losing those assets.

A DMP is only an option if your creditors are willing to negotiate or voluntarily be a part of the agreement.

Finally, think about your credit score. If you’re considering bankruptcy, your credit might already be fairly low, but if your credit is still in decent shape, you might want to protect it. A Chapter 13 bankruptcy lasts a long time and so it will take a long time before you can rebuild your credit. A successful DMP, meanwhile, should have little impact on your credit score.

How Resolve can help

Managing your debt can be a challenging process where professional guidance really pays off. If you’re considering a debt management plan, Resolve can connect you with a trusted partner for a free consultation and payment quote.

If you’re thinking about bankruptcy, we can not only connect you with licensed professionals in your state for a no-cost initial consultation, but we also can help you understand what bankruptcy would mean for your individual financial situation.

If you haven’t yet created a Resolve account, click here to get started.

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