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Bankruptcy and credit counseling are two of the most effective means of taming or eliminating debt that has resulted in insolvency. Insolvency occurs when income has fallen or debt has risen to the point that paying all essential bills and expenses has become impossible. Without a restructuring or the elimination of debt, serious delinquency or default is inevitable or has already occurred.

Personal bankruptcy and debt consolidation are two different options that make sense under different circumstances.

The best protection from insolvency is long-term financial planning. Anticipating expenses ahead of time and setting aside cash to pay them helps avoid credit card debt, a major cause of household insolvency in America. However, not all events can be predicted.

Economic shocks, such as the meltdown of 2008, are difficult for most people to predict until it’s too late, otherwise most people would not have bought a home in the years leading up to the mortgage crisis. In such cases, where debt becomes insurmountable, credit counseling or bankruptcy are the necessary antidotes.

The difference between bankruptcy and credit counseling

Credit counseling involves renegotiating debt with creditors. Unlike bankruptcy, it is based on contract law rather than statute. When you take on loans, you enter into a contract that obligates you to repay the principal and a specified amount of interest according to an agreed upon schedule. When insolvency occurs, meeting this agreed upon repayment schedule has become impossible due to a lack of adequate funds. Credit counseling seeks to alter the existing contract in order to make repayment possible and cure insolvency.

From the creditor’s perspective, changing the contract makes sense because receiving some money is better than no money. The cost of taking a debtor to court often only results in further losses because collection is impossible, or the lawsuit forces the debtor into bankruptcy. For this reason, many creditors simply sell the defaulted debt contract to a collections firm at a steep loss. When a renegotiated payment arrangement nets more money than selling the debt, creditors usually agree.

From the debtor’s perspective, credit counseling makes sense when the renegotiated payment arrangements cure insolvency. For this to occur, the new payment schedules must provide the debtor with positive cash flow every month so that he or she avoids falling back into insolvency. Credit counseling usually involves lowering of interest rates, a big benefit when it comes to high interest credit card debt.

Credit counseling also does not require the liquidation of property. This is especially important for homeowners and households with significant amounts of property that falls outside of bankruptcy exemptions. For example, in a Chapter 7 bankruptcy, 401(k) assets survive liquidation, but stocks and bonds held in a regular account must be sold to repay creditors. The same applies to homes when equity is above certain levels.

If credit counseling fails to restore solvency and the debtor has significant assets that would be liquidated in a Chapter 7, Chapter 13 bankruptcy may provide the solution.

The difference between a Chapter 13 bankruptcy and credit counseling

Chapter 13 bankruptcy bears similarity to credit counseling in that both involve repaying creditors according to modified schedules. To succeed, a Chapter 13 must provide a 3- to 5-year repayment plan that the court approves. This plan may repay all or some of the debt. The debtor can avoid forfeiting many types of properties, such as a principal residence. Because of the legal rights afforded to debtors in Chapter 13, the debtor may be able to compel creditors to accept a proposed repayment plan.

The difference between credit counseling and Chapter 7 bankruptcy

A Chapter 7 bankruptcy is fundamentally opposed to credit counseling. So you need to make sure it is the right choice for your situation. While credit counseling seeks to modify repayment, Chapter 7 seeks to wipe away debt as completely as possible. Most consumer debt, including credit card debt, mortgages, vehicle loans, personal loans, payday loans and more are eliminated in Chapter 7 unless the debtor reaffirms the debt in order to keep property such as a car. On the day of the bankruptcy filing, the debtor is freed from all eligible debt obligations.

Not all debts are eliminated in a Chapter 7. Student loans, child support, alimony, taxes and other priority debt survive a Chapter 7.

Chapter 7 has disadvantages. The bankruptcy remains on the borrower’s credit report for 10 years. Particularly in the first few years after a bankruptcy discharge, the bankruptcy hinders the ability to get good credit offers, may cause higher insurance premiums, and can disqualify the debtor from taking out a mortgage or leasing some rental homes. Despite these disadvantages, when attempts to regain solvency fail and the borrower has no non-exempt property to protect the best solution is often filing a Chapter 7 without delay.

Credit counseling works very well for debtors who are experiencing temporary hardships, such as becoming insolvent after a layoff. Provided the debtor regains a similar income, he or she likely becomes solvent again with the help of credit counseling. However, when in danger of foreclosure or other property seizure, bankruptcy is often the only way to save the property. When the insolvency is of a long-term or permanent nature, the only possible relief often comes from a Chapter 7.

To learn more about personal bankruptcy and other debt relief options seeking advice from an experienced bankruptcy law firm is wise. Embarking on a journey to regain your finances and establish a secure future requires diligence, patience and honesty. The bankruptcy attorneys at Hines Law are compassionate and have both the experience and expertise to help.

Specializing in Chapter 7 and Chapter 13 filings, Hines Law represents clients throughout Massachusetts with clear and practical advice. Call us at 781-27-0411 set up a Free bankruptcy case evaluation!