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Debt Relief Vs. Bankruptcy

Andrew Dehan7-minute read
September 21, 2020

Medical bills after an accident, divorce, a lost job – there are endless ways that you can fall into debt. A debt relief program can help you restructure or reduce what you owe if you struggle to keep up with your payments. Bankruptcy might be the best solution for you if you’re deep in debt with no way out. How do you know which strategy is best?

Debt relief and bankruptcy can both help you tackle debt and get back on the path to healthy finances. Let’s take a closer look at the differences between debt relief and bankruptcy so you can decide which option is right for you.

Is Debt Relief Better Than Bankruptcy?

Before we talk about whether debt relief or bankruptcy is better, let’s go over the differences between the two. Both are solutions to overwhelming debt, but it’s important to know that they absolve you of your debt in very different ways.

Bankruptcy is a legal process that can help relieve you of certain types of debt. You must hire a bankruptcy lawyer before you file for bankruptcy. The goal of most bankruptcies is to wipe away debt and give you a fresh financial start. Declaring bankruptcy is a very effective way to eliminate debt, but it isn’t a complete solution. There are a few kinds of debt that you cannot discharge in bankruptcy. For example, owed child support payments and most student loans are exempt from bankruptcy.

There are two main types of bankruptcy classifications:

  • Chapter 7: During a Chapter 7 bankruptcy, a court may order you to liquidate some of your property. Property essential to everyday life (like your clothing and furniture) is exempt from liquidation in most states. Once you sell off your eligible assets and return the money from the sale to your creditors, the court relieves you of your remaining debt. Chapter 7 bankruptcies have a larger impact on your credit than Chapter 13 bankruptcies.
  • Chapter 13: A court looks at your finances and orders you to complete a payment plan to your lenders in a Chapter 13 bankruptcy. Most payment plans last 3 – 5 years. When you finish your payment plan, a court wipes away your remaining debts. Chapter 13 bankruptcies are typically more expensive than Chapter 7 bankruptcies. However, they allow you to keep your property and have less of an effect on your credit score.

No matter which type of bankruptcy you choose, you’ll see a significant impact on your credit score. It can take years to recover from the effects of a bankruptcy. When you have a bankruptcy on your credit report, you’ll have a much harder time opening new cards and loans.

Unlike bankruptcy, most types of debt relief don’t involve a court or legal proceedings. Instead, you negotiate with your creditors and create a plan to repay all or a portion of your debt. There are multiple types of debt relief, including:

  • Credit counseling: Do you have a large amount of debt and you aren’t sure where to begin repayment? You might want to call a credit counseling agency. Credit counseling agencies look at your income and debt and recommend a solution. They may also help you enroll in other debt relief programs.
  • Debt consolidation: Debt consolidation takes debt from multiple sources and combines it into one loan. Many homeowners consolidate their debt with a cash-out refinance because mortgage interest rates are lower than other types of debt. You can also use a personal loan to consolidate debt. Debt consolidation doesn’t reduce what you owe but it can make payments more manageable.
  • Debt management plan: When you accept a debt management plan, you make a monthly payment to a credit counseling agency. Your agency then distributes a percentage of your payment to all your creditors, closing accounts as you pay them off. Credit counseling agencies also often negotiate lower interest rates with your creditors to save you money.
  • Debt settlement or negotiation: Debt settlement or debt negotiation plans allow you to pay less than what you owe on your current accounts. Your creditors may agree to reduce your outstanding balance if they think you might file for bankruptcy.

Each type of debt relief has its own benefits and drawbacks. We’ll take a closer look at how debt relief methods affect your credit score in later sections.

So, is debt relief better than bankruptcy? The answer depends on your situation. If you have enough money coming in to cover a percentage of your debts, debt relief is usually the better solution. Relief programs are easier and more cost-effective than filing for bankruptcy because you don’t need a lawyer to use them. If you’re deep in debt or you owe money to multiple creditors, bankruptcy might be the only reasonable solution. You should always view bankruptcy as a last resort.

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How Does A Debt Relief Program Affect Your Credit?

The effect that you’ll see on your credit report depends on the type of debt relief program you choose. 

A call to a credit counseling agency won’t affect your score. However, the company might enroll you in another type of relief plan that does. Debt consolidation also usually has a minimal effect on your credit score as long as you make your payments on schedule. 

A debt management plan will usually lower your credit score. When you accept a debt management plan, you typically agree to allow your counseling agency to close credit cards as you pay them off. Closing a card lowers your credit score because it reduces your overall line of available credit. However, this effect will have a minor long-term effect on your credit score. You can repair your credit by opening a secured credit card after you complete your management plan.

If you accept a debt settlement, you may or may not see an effect on your credit. Some lenders may agree to avoid reporting a credit settlement to your credit reporting bureau as long as you’re able to make a lump-sum payment. However, this isn’t a guarantee. Many lenders will accept your payment and then report that you settled your debt. This will usually appear on your credit report as “settled” or “paid less than full balance.” These items hurt your credit score. 

Debt settlement might also damage your credit score indirectly. Most creditors won’t agree to settle a debt with you if you aren’t already behind on payments. Creditors usually need to believe that you’re at a serious risk of bankruptcy before they’ll agree to settle your debt. If they don’t think there’s an immediate risk of bankruptcy, they generally won’t agree to settle. You usually need to fall behind on your payments by at least 180 days before you have a chance of settling your debt. This equals 6 months of missed payments – each of which will negatively impact your credit score. 

What Is The Difference Between Debt Relief And Debt Settlement?

Debt settlement is a type of debt relief that absolves you of a portion of your debt. When you take a debt settlement, you agree to give your creditor a lump-sum payment that covers some of your debts. In exchange, your lender agrees to forgive your remaining balance.

Why would a credit card or loan company agree to accept a lower balance than you owe? Creditors know that if you file for bankruptcy, they won’t get any of their money back. Unsecured debt (like credit card debt) is easily wiped away during bankruptcy. This leaves the debtor with nothing. Even if you file for Chapter 13 bankruptcy, your creditor will likely receive much less money than you actually owe.

If your creditors believe that you’re very likely to file for bankruptcy, they might be willing to settle your debt. However, keep in mind that creditors have no obligation to accept your settlement plan or forgive any amount of your debt.

The term “debt relief” is a catchall phrase that refers to any program or method you use to alleviate your debt. Debt settlement and bankruptcy are both types of debt relief, but debt relief doesn’t refer to any specific method of controlling your debt.

Can You File Bankruptcy If You Are In A Debt Relief Program?

You can file for bankruptcy while you’re pursuing debt relief. If you lose your income or you’re forced to take on even more debt, you might have no choice but to file. However, this isn’t usually recommended, especially if you’ve already begun making payments toward your debt. You won’t receive any of the money you paid to your creditors back after you complete the bankruptcy process.

You’ll also still need to complete the required bankruptcy steps even if you’re already enrolled in a repayment program. This can include liquidating your assets and changing your repayment schedule. Any court order you receive will override or cancel agreements you made with your creditors. If you take a form of debt relief that harmed your credit, a bankruptcy can compound these effects and lower your score even more.

Carefully consider all your debt relief options before you choose a course of action. There’s no point in signing up for a debt relief program if you have no way to cover the repayments. Take a hard look at your finances, know exactly how much you owe and explore each of your options before you proceed.


Debt relief and bankruptcy are both methods that you can use to tackle overwhelming debt. When you file for bankruptcy, you petition a court to absolve you of some or all your debt. You may need to sell your possessions or follow a repayment plan before a court discharges your debt. Bankruptcy cannot clear every type of debt but is useful for clearing away unsecured debt. Your credit score will drop significantly after bankruptcy.

“Debt relief” is an umbrella term that covers multiple methods of tackling debt. Credit counseling, debt consolidation and debt settlement are all examples of debt relief. Your credit score may or may not decrease after debt relief, depending on the method you choose. Debt relief programs can be a better method of paying down debt if you have enough income to make your payments. Bankruptcy might be a more effective option if you have an overwhelming amount of debt and little income.

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Andrew Dehan

Andrew Dehan is a professional writer who writes about real estate and homeownership. He is also a published poet, musician and nature-lover. He lives in metro Detroit with his wife, daughter and dogs.