Debt Relief vs. Bankruptcy: Key Differences and How to Know Which Is Best

When you’re struggling to pay off a crushing amount of credit card, medical, or other debt, bankruptcy might feel like your only option. Before you file bankruptcy, however, you may want to consider using a debt relief company, which will try to negotiate with your creditors to settle your balances for a lower amount. On the other hand, bankruptcy eliminates most of your debts. 

Both options come with trade-offs that can damage your credit. However, each has advantages over the other. Below, you’ll find what you need to know to make an informed decision about whether debt relief or bankruptcy is right for you.

Table of Contents

1. Debt relief vs. bankruptcy: Key differences
2. What is debt relief? 
3. What is bankruptcy? 
4. Debt relief vs. bankruptcy: Which should you choose? 
5. What to do if you’re considering bankruptcy
6. What to do if you’re considering debt relief

Debt relief vs. bankruptcy: Key differences

Debt relief	Chapter 7 bankruptcy	Chapter 13 bankruptcy
Company attempts to negotiate with your creditors to settle balances for less	Liquidate (sell) nonexempt assets and use the proceeds to repay creditors; remaining unsecured debts after liquidation and repayment may be discharged	Reorganize debts via a court-approved repayment plan based on income and expenses
Must pay settlement fees (typically 15% to 25% of your enrolled debt), plus interest and fees on debt consolidation if you choose to consolidate	$335 court fees; Attorney fees ($1,500 – $5,000); Up to $50 for credit counseling	$310 court fees; Attorney fees ($1,500 – $5,000); Up to $50 for credit counseling
Typically last 24 – 48 months	Lasts 4 – 6 months	Lasts 3 – 5 years
Past-due accounts stay on your credit report for up to seven years	Stays on credit report for up to 10 years; Credit score may drop by around 200 points	Stays on credit report for up to or seven years; Credit score may drop by around 200 points
No loss of assets	You could lose assets, depending on state law	You typically won’t lose assets

What is debt relief? 

Debt relief is a process that helps individuals or businesses reduce or manage their debts, often through negotiation, consolidation, or structured repayment programs. It’s designed to ease financial pressure and make repayment more manageable. 

However, debt relief can come with trade-offs, such as fees, potential credit score impacts, and tax implications for forgiven debt, making it important to weigh the benefits against the drawbacks before committing.

Types of debt relief 

Debt relief companies usually offer a couple of types of debt relief. Here’s how those debt relief options and programs work.

1. Debt settlement

This method of debt relief isn’t a loan. An agent with a debt relief company will negotiate with your creditors to try to settle each debt for a lower amount. However, debt relief companies can’t guarantee that they’ll reach a settlement with your creditors. 

To build funds in an escrow account, which the company will use to offer a settlement, debt relief companies typically require monthly deposits. At the same time, you must stop paying your creditors, which results in past-due accounts. Once you approve a settlement, you’ll pay a settlement fee to the debt relief company. 

2. Debt consolidation

When you apply to find your options with a debt relief company, many also check your eligibility for debt consolidation services with its partner lenders, which means you’ll combine your unsecured debts into one balance that you’ll pay off, often in a streamlined monthly payment. 

If the company offers this option, its representatives can help you determine whether this makes more sense than settlement and how to proceed. 

Pros and cons of debt relief

Before signing up for debt relief, it’s important to weigh the pros and cons of debt settlement and debt consolidation. You’ll likely only want to take advantage of a company’s debt consolidation or debt settlement services—otherwise, you’d make payments on the debt consolidation as well as depositing monthly payments into an escrow account for settlement funds.

Below are the pros and cons of working with a debt relief company. 

Pros

• Pay less than you owe

  Depending on the settlement amounts and fees, you may save thousands of dollars on what you owe.

• Make one payment a month

  You’ll make only one monthly payment to the debt relief company instead of keeping track of monthly payments.

• Keep funds safe in an escrow account

  Money is typically deposited into an FDIC-insured escrow accounts

Cons

• Will harm your credit

  Stopping payments to creditors can damage your credit and appear on your credit report for up to seven years.

• Settlement isn’t guaranteed

  Debt relief companies can’t guarantee that creditors will offer a lower settlement. Some may not even agree to negotiate for a lower amount.

• Settlement fees

  Debt relief companies charge a fee for each settlement of 15% to 25% (of the enrolled amount, not the negotiated settlement amount). Depending on the settlement amount, you may end up paying more in fees than you saved.

• Creditors may sue

  While you’re building escrow funds with monthly payments, your creditors might sue you for amounts owed.

• Might owe taxes

  The amount of debt forgiven might be taxable.

What is bankruptcy? 

Bankruptcy is a legal process that helps individuals overwhelmed by debt find relief through court-approved solutions. It can eliminate certain debts or establish a repayment plan, providing protection from most collection efforts. 

While bankruptcy offers a fresh start, it has significant downsides, including long-term credit impacts and potential asset loss. It’s essential to understand these considerations before pursuing this option.

Types of bankruptcy 

The two most common types of bankruptcy for individuals are Chapter 7 and Chapter 13. 

1. Chapter 13 bankruptcy allows you to keep all property and assets and create a repayment plan to pay off your creditors with installment payments over a period of three to five years. 
2. Chapter 7 bankruptcy has no repayment plan like Chapter 13. Instead, an impartial trustee is appointed to sell (liquidate) your nonexempt assets and use the funds to pay your creditors. Exemptions to protect certain property exist and vary, depending on federal and state laws. 

We recommend consulting with an experienced bankruptcy attorney familiar with your state laws. With Chapter 7 bankruptcy, eligible debts can be discharged in four to six months, offering a fresh start to rebuild your credit and finances.

Pros and cons of filing for bankruptcy 

It’s important to know the pros and cons before filing for bankruptcy.

Pros

• Get rid of debt

  Chapter 7 discharges many or most debts, depending on state bankruptcy laws.

• Pay creditors over time

  Chapter 13 allows you to pay creditors in regular installments for up to five years.

• Creditors can’t pursue payment.

  As soon as you file Chapter 13, you receive an automatic stay where creditors must stop contacting you for payment until a repayment plan is finalized or the bankruptcy is discharged. You also receive an automatic stay, which varies, when you file Chapter 7.

• Get a fresh start

  Once the bankruptcy is final, many borrowers find the worry and anxiety associated with having too much debt lifted.

• Certain assets may be exempt

  Depending on state bankruptcy laws, your home or other property may be exempt.

• Debt-to-credit ratio may improve

  Once your debts are discharged or repaid, you won’t have as high of a credit utilization ratio—which makes up about 30% of your credit score—as long as you don’t accrue more debt.

Cons

• Credit score will drop

  When you file bankruptcy, your credit score could drop by around 200 points.

• Bankruptcy appears on your credit report

  Chapter 13 bankruptcy will appear on your credit report for up to seven years. Chapter 7 appears for up to 10 years

• May need to sell assets

  If you file Chapter 7 bankruptcy, you may be required to sell your home, car, or other property, depending on state law.

• Not all debts can be discharged

  Under Chapter 7, some debts can’t be discharged, including child support, alimony, most federal student loans, and certain personal injury debts.

Debt relief vs. bankruptcy: Which should you choose? 

It’s important to choose the best option for your financial situation. Many bankruptcy attorneys offer a free consultation to gather information about your finances and creditors and come up with the best option for your situation. You may not be allowed to file Chapter 7 or Chapter 13 in some situations.

Consider contacting debt relief companies to find out what kind of debt relief program you qualify for and its requirements. Ask the debt settlement agent about the percentage for settlement fees and the monthly payment amount, how long you can expect to be in the program, and what percentage of customers’ debts have been settled for a lower amount.

Neither of these options is ideal because your credit will take a hit for up to seven years with debt relief or Chapter 13 and up to 10 years if you file Chapter 7. However, if you’re falling behind on payments or struggling with overwhelming debt, both options could get you out of debt.

If…	Consider…
You want to make monthly installment payments to pay off creditors	Chapter 13 bankruptcy
You want to take a chance to settle your debts for lower amounts	Debt relief
You don’t have many assets that would be liquidated and want your debt discharged	Chapter 7 bankruptcy
You don’t want to be harassed by creditors	Bankruptcy
You’re seeking to consolidate or simplify your financial life	Debt consolidation (through a debt relief company or a loan)
You’re at risk of losing assets that you don’t want to give up	Chapter 13 bankruptcy
You’re struggling to make monthly payments on debt	Debt relief
You have a high DTI	Debt relief
Your debt is causing you serious stress	Debt relief

If you’re considering bankruptcy or debt consolidation, ask yourself whether you have any other choices.

Bankruptcy and debt relief options are typically the last option. Debt is a black hole for building wealth, especially at high interest rates and when bearing down upon one’s credit score.

Debt must be addressed immediately in this situation. Balance losing assets or having long-term financial consequences against the current cost of debt. It is much easier to build up assets again with a strong cash flow than to have assets with most of your cash flow going to debt.

Kyle Ryan, CFP®

What to do if you’re considering bankruptcy

If you’re considering bankruptcy, consult a reputable bankruptcy attorney to assess your financial situation and determine whether bankruptcy is the right option for you. They can help you understand which type of bankruptcy fits your needs and guide you through the filing process. 

Look for free resources, such as credit counseling agencies approved by the U.S. Department of Justice, to explore alternatives and meet pre-filing requirements. Taking these steps ensures you make an informed decision while minimizing risks and maximizing potential benefits.

What to do if you’re considering debt relief

If you’re considering debt relief, begin by researching reputable companies with a proven track record. National Debt Relief is the highest-rated option in our stringent editorial ratings. 

To avoid scams, it’s crucial to choose a company that is well-reviewed and transparent about fees and outcomes. To get started, assess your financial situation, set realistic goals, and consult our best debt relief page for trusted options to regain financial stability.