Debt Consolidation vs. Bankruptcy vs. Debt SettlementWhen debt becomes overwhelming, it is tough to make a decision about how to deal with it. Let me start by saying that every person and every situation is different. The right choice for one person may not be the right choice for another.

People will often come in to see us for a free consultation asking about the pros and cons debt consolidation vs. bankruptcy vs. debt settlement. I will try to lay them out for you here in an unbiased manner. I will end the article with my opinion. No matter which option you choose, you should try to speak with a bankruptcy attorney in your area to see what your best option is. Attorneys, unlike most businesses are ethically bound to give you advice that is not tied to their profit. The advice you get should be what is in your best interest, not the best interest of the person or company that is helping you.

Debt Consolidation Programs

First of all debt consolidation programs are where you pay a third-party company to attempt to work out payment arrangements on your behalf with your creditors. I am not discussing consolidation loans in this article. The way that this works out in practice is that the debt consolidation company begins taking your money and putting it into an account. The consolidation company then calls or writes the the creditors to ask them if they would be willing to accept certain terms. They often work one creditor at a time. This means that if you have many creditors, some may wait quite a while to begin to see any money. Many of your creditors are willing to do this. Some creditors will simply not deal with debt consolidation companies.


  1. You have the satisfaction of paying back some of your debt.
  2. You may be able to purchase a house less than 2-4 years from when you finish the program.
  3. It should be less expensive than paying back the debts in full.
  4. It can be done even when you have significant equity in property.


  1. Some creditors will not take part and may sue you even while you are paying the consolidation company.
  2. You will have a hard time rebuilding your credit until you have completed the program.
  3. The repayment periods may be loooong.
  4. You will receive a 1099c for any forgiven debt and will have to pay tax on it as though it were income.
  5. Some creditors may be complete scams, as in you don’t even owe the debt.
  6. The costs of the programs are relatively high in comparison to the other options


Bankruptcy comes in four main different chapters that individuals can file. One of them, chapter 12, is only for farmers and fishermen, the other 3, chapter 7, 11, and 13 are more common. For a fraction of the price of debt consolidation you can get rid of almost all of your debt in a chapter 7.


  1. Chapter 7 bankruptcy is fast. For most cases they close 3 months after the case is filed. At that point, your debts are discharged.
  2. Chapter 13 bankruptcy takes 3-5 years, during which, none of your creditors can sue you or garnish your wages while you are in the bankruptcy.
  3. Bankruptcy stops garnishments, foreclosures, harassing phone calls from creditors, and can be used to get driver’s licenses back.
  4. You do not pay taxes on discharged debts.
  5. You can start rebuilding your credit as soon as your chapter 7 is discharged or your chapter 13 is confirmed.
  6. Bankruptcy has very predictable outcomes if you go with an experienced attorney.


  1. If you file a bankruptcy you have to wait 2-4 years to take out most types of mortgages.
  2. There is an unwarranted social stigma.
  3. There is a danger that you lose property or the ability to get a discharge if you do not tell the truth.

Debt Settlement

This is where you deal with the creditors one by one to try to save some money. You can do this on your own, with an attorney, or with a company that specializes in debt settlement. By far the best way to do debt settlement is to save up some money and to make an offer of a lump sum payment. Some creditors will take payments over a longer period of time, but the amount you save off the the balance goes way down. Figure 30-60% if you have a lump sum and 50-100% if you are doing payments.


  1. This can be very fast depending on how old the debt is and whether or not it is with the original creditor.
  2. Of the three options discussed, debt settlement can have the smallest credit consequence.
  3. Generally cheaper than a debt consolidation program.


  1. You will receive a 1099c and have to pay the IRS if you end up saving more than $500. For example, say you have a $25,000 debt that you settle for $10,000, you will then be taxed on an additional $15,000 of “income.” That would leave your total settlement cost at closer to $13,000.
  2. It does still negatively affect your credit.
  3. You really need access to at least 1/3 of the debt as cash if you want to get a decent settlement.
  4. Some creditors may be complete scams, as in you don’t even owe the debt.
  5. More expensive than bankruptcy.

My Opinion:

It may be that I am a hammer and all the world looks like nails to me, but the fact is, if you qualify for bankruptcy, it is the best option in most cases. This opinion would change some depending on what state you live in and how much property you can exempt under the bankruptcy code. If you file a bankruptcy you do have to wait 2-4 years for most home loans, but you need some time to come up with a down payment anyway, right? If you file a bankruptcy you can literally buy a car the day after filing (you definitely want to talk to your attorney before doing this though). If you are employed and you aren’t afraid to wade back into the credit pool, you can have your credit score back to 720 in one to two years.

Best of luck,

Steven M. Palmer WSBA #48823