Chapter 13 or Debt Consolidation?

Over the course of my career, many people have come to my office seeking to resolve issues of situations where they face serious debt. After meeting with them and determining that they would not be eligible to file for Chapter 7 bankruptcy relief, the choice often comes down to one of two options: working out a plan of debt consolidation or filing for bankruptcy relief under Chapter 13.

I have found that generally, in the majority of these cases, Chapter 13 may be the better option.

With debt consolidation, you or your representative negotiates with each of your creditors to eliminate or, at least, lessen the burden of your debts. Generally speaking, a successful negotiation results in either lowering the amount of money you owe, reducing the interest rate on your debt, or a combination of both. This eases your debt situation and makes life easier for you. The obvious benefit to the creditor is it’s always better to get something rather than nothing.

The case against debt consolidation

Debt consolidation also comes with several “negatives,” including:

  • The creditor has to opt in. Participation in the debt consolidation process is purely voluntary on a creditor’s part. They aren’t legally obliged to negotiate or participate at all.
  • The creditor doesn’t have to stick to the plan. Even if a creditor agrees to negotiate a debt consolidation plan, there’s usually nothing that obligates them to stay with that plan. They can back out at any time. Therefore, you have little to no protection if the creditor decides to resume their debt collection activity (including filing a lawsuit to recover their debt).
  • There are no statutory cost limits to debt consolidation. In other words, if you hire an attorney or debt consolidation company to represent you, you have to pay whatever terms they charge for their services—usually a percentage of your overall debt. In cases of substantial debt, that can add up to anywhere from 25 to 40 percent.

The case for Chapter 13

Unlike debt consolidation which generally only applies to consumer or credit card debt, Chapter 13 deals with all types of debts (credit card, medical bills, mortgage, car loans, etc.). It can be far more comprehensive than a debt consolidation plan.

When a debtor files for Chapter 13 bankruptcy, all collection activities (including lawsuits) come to an immediate halt. The court establishes legal mechanisms to determine how much of the debt will be repaid. A “means test” is applied—the calculation by which it’s determined how much money should be available to be utilized in a monthly payment plan. At the end of your payment plan, any remaining balances of any dischargeable debts are ordered discharged. If, for example, the court determines you’re only able to pay 10% of your dischargeable unsecured debt, then at the end of the bankruptcy period, the remaining 90% is wiped off the books.

Unlike debt consolidation, creditors are legally obliged to accept whatever arrangements the court orders. If creditors choose not to participate, generally speaking, they are completely out of luck.

Typically, a Chapter 13 plan lasts anywhere from three (3) to five (5) years (a debt consolidation can go on “forever”). Having a fixed repayment schedule through bankruptcy can be preferable to a debt consolidation plan which may still incur interest payments and late fees.

My recommendation

I strongly recommend consulting an attorney when exploring either of these options. Taking either of the above described debt resolution options while being unaware of the various legal ramifications can make the process more difficult (and more expensive) for you in the long run.

A final point: if you do choose to attempt debt consolidation, I suggest hiring an attorney or law firm, rather than a debt consolidation company. These companies often have little accountability, meaning there’s no governing board or an organization you can appeal to if things go wrong. Attorneys, on the other hand, are far more accountable for their actions, since they are subject to state bar and licensing requirements.

Overwhelmed by substantial debt or have any questions about the above topic? The Law Offices of Ian S. Topf offer free consultation in a variety of issues, ranging from bankruptcy, family law/divorce, and estate planning to criminal/DUI matters and landlord/tenant disputes.