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Debt Consolidation or Bankruptcy? Which is Better?

Home > Debt Consolidation > Debt Consolidation or Bankruptcy? Which is Better?

If you’ve got debt in America, you’ve got company. A new study reveals that 80.9% of baby boomers, 79.9% of Gen Xers, and 81.5% of millennials are carrying credit card debt and that can invite chaos into an orderly life.

We might as well run up a red flag and change our name to the United States of Debt!

We all know the drill on how we got here: The company downsizes, the mortgage balloons, the surgery isn’t fully covered, tuition soars while the Honda sputters.

The good news is there’s plenty of help. There are some well-known methods – bankruptcy and some form of a debt consolidation plan – that people have used to help themselves eliminate debt, according to Northwestern University marketing professor Blake McShane of the Kellogg School of Management.

His paper in the Journal of Marketing Research identifies the traditional methods that have helped hundreds of thousands of people get debt-free.

Bankruptcy: The Most Dramatic Choice

McShane worked with another marketing professor at Northwestern, David Gal, to identify the extremes people will take to get themselves out from under debt.

“At one extreme, there are consumers who can afford to pay off their debts over time from savings and income without any changes to the structure of their debts,” Professors McShane and Gal said.

This strategy requires “substantial lifestyle changes.” But not everyone has a tech patent up their sleeve, a long-lost millionaire uncle, or debt that can be dissolved by not eating out for six months.

“At the other extreme,” the professors say, “there are consumers who choose to walk away from their debts, either by defaulting or by declaring bankruptcy.”

There are good reasons people choose bankruptcy. A 2016 study by the American Bankruptcy Institute found that nearly 500,000 people filed for Chapter 7 bankruptcy and 95.5% of them had their debts discharged. That means they walked away debt free.

The same study found that individuals who used Chapter 13 bankruptcy didn’t have as much success, but more had their debt discharged (166,424) than didn’t (164,626).

In a Chapter 7 bankruptcy, with the aid of a bankruptcy attorney, you get a fresh start by exposing all your assets to a trustee collecting for creditors. A Chapter 13 bankruptcy, for those with regular income, allows you to keep some assets and pay off your debt over time.

In both cases a bankruptcy craters your credit report for up to 10 years because your lenders are paid nothing or a small amount. It can be very difficult to get a loan during that time. Bankruptcy can also bruise your reputation. Bankruptcy judgments are public records that any lender, or someone hiring you for a job, can easily find. The fallout can chase you for long time.

Other Options

If you can afford one of the less extreme options associated with debt consolidation, the Federal Trade Commission recommends you use a credit counselor with a legitimate nonprofit organization accredited by the National Foundation for Credit Counseling (NFCC). Don’t do business with high-pressure salesmen. If you smell a rat, it probably is one.

An accredited nonprofit counselor should provide a 30-40 minute counseling session that includes creating a budget and examining your monthly income and expenses before recommending a solution.

Credit counselors at nonprofit debt relief agencies typically offer one of three fixes for the problem: debt management plan, debt settlement or, if the situation has escalated beyond repair, bankruptcy.

The other solution is a Do It Yourself approach that would include a debt consolidation loan.

Debt Management

This is a clear choice if you can show that you have enough income to afford a monthly payment schedule. The advantage to this method is you’re not taking on a new loan.

Your credit counselor works with your lenders to make it easier to pay back the debt you already have. They can obtain a lower interest rate and reduce monthly payments so you can pay off the principal more quickly.

Credit counselors at NFCC-certified nonprofits can get your interest rate on credit cards reduced in most cases down to 8% or less, a big drop from the typical 20-30% you might currently be paying. They can also work to eliminate late fees.

The risk is that if you miss a payment, the card company may revoke the deal and jack the interest rate right back up. A typical program may take three years, but there’s no quick fix in the get-out-of-debt game.

All of these methods will affect your credit report, but a debt management program notation is removed as soon as you exit the plan, while a Chapter 7 filing remains for 10 years, and a Chapter 13 report and debt settlement will be there for seven years.

Debt Settlement

While not as dire as bankruptcy, debt settlement can be risky. It is designed for consumers who can’t afford to make monthly minimum payments to creditors.

Debt settlement companies ask you to stop paying the credit card companies and instead send money to them so they can put it aside and make a one-time settlement offer to the lender.

A debt settlement company promises to reduce your debt by 50% or more, but there’s no guarantee of that rate of success and the process usually takes three to four years, if the card company will even deal with debt settlement companies. Some don’t.

By the time you add in the penalties for late or non-payment, plus the fee for the service, you end up saving maybe 20%, and you damage your credit report and credit score for the next seven years.

Debt Consolidation Loans

With this solution, you apply for a debt consolidation loan from a bank, credit union or online lender and, if approved, use it to pay off all your credit card debt. That leaves you with one payment, not five or more (the average American has five credit cards).

The interest rate on this loan is typically lower than that on many if not all of the original cards, giving you a lower monthly payment. But to obtain this lower interest rate, the loan must be secured by your assets, usually home equity, putting your home at risk if you fail to meet obligations.

Another disadvantage is you’re opening a new line of credit, which can affect your credit score.

Seek Small Victories

Professor McShane says no one approach works for everyone: “Every circumstance is unique. Every individual is unique,” he said.

Before you choose how to attack your debt, Professor McShane has a small tip that could make a big difference, an optimistic new way of looking at your debt woes.

He advises consumers to seek out what he calls, “small victories.”

Traditionally, financial gurus have said to pay off the highest interest-rate credit cards first. The U.S. Government still recommends it. It’s common sense.

But according to ground-breaking research by Professors McShane and Gal, paying off the highest interest rate or the biggest loan first isn’t the most important factor in success.

Someone with, for example, $10,000 in credit card debt spread over four accounts—one $6,000 debt, one $2,000 debt, and two $1,000 debts—was much more likely to succeed if they paid off the two $1,000 debts first instead of the $2,000 debt, though the same amount of debt was retired.

What mattered most was the pride and confidence gained by closing two of four accounts instead of just one.

“The unequivocally right thing to do is pay off loans in order of interest rate, and if we were all purely rational economic actors that is indeed what one should do,” Professor McShane said in an interview with

“But all of us aren’t purely rational creatures, and we found empirical support that psychological factors can be helpful. Paying off a small balance — a quick win! — can make you feel good about yourself. Checking that off may help you get out of debt.”

About The Author

Mike Capuzzo

Mike Capuzzo is the New York Times-bestselling author of Close to Shore and The Murder Room. A former staff writer for The Miami Herald and The Philadelphia Inquirer, he has won more than a hundred journalism awards. Publishers have nominated his books and articles for the Pulitzer Prize six times.


  1. Gal, David, and McShane, Blakeley B. Can Small Victories Help Win the War? Evidence from Consumer Debt Management. Journal of Marketing Research, Vol. XLIX (August 2012), p. 487–501.
  2. Backman, Maurie. (Feb. 15, 2018). It’s Official: Most Americans Are Currently in Debt. Retrieved from The Motley Fool,