In this economic downturn, a lot of responsible people are among the long-term unemployed and drowning in debt. If your credit score is already plummeting, is it worth it to try debt negotiation or consolidation? Or should you file for bankruptcy?

The truth is there's no one-size-fits-all answer. Whether to file for bankruptcy or seek alternatives to bankruptcy is a decision you need to make based on concrete information, understanding the options available, and a clear look at your goals.

The very first thing you should do is contact a reputable credit counselor who can help you determine how much you can afford to pay. Don't believe slick advertisements claiming they can settle your debts for 40 cents on the dollar.

Look for companies that belong to the National Foundation for Credit Counseling (NFCC) or the Association of Independent Consumer Credit Counseling Agencies (AICCCA). Bankruptcy lawyers are also a good resource, and the Bankruptcy Legal Group offers some of these services.

Consider Debt Negotiation for Temporary Setbacks

If you feel confident that paying off your debts will soon be within your reach, debt negotiation or consolidation may offer solutions:

  • A negotiated debt solution won't affect your credit as negatively as bankruptcy
  • Employers and insurers who rely on credit checks are less likely to hold debt settlement against you than bankruptcy

On the downside, many credit card companies won't even work with you until you stop making payments - sometimes not until you're 90 days late, which will result in collection actions. Plus, until you reach an agreement, your interest rate will go up, increasing your minimum payments and/or reducing the principal paid each month.

Look Into Bankruptcy If You Need a Fresh Start

If your job prospects are uncertain or you have significant debt, you may do your credit better service in the long run by declaring bankruptcy:

  • If you're unemployed, you probably qualify for Chapter 7, where most of your debts are wiped out
  • Any debt forgiven by creditors is subject to taxation, but debts discharged in bankruptcy are not
  • A futile struggle to pay off debt is probably worse for your credit than a bankruptcy

Bankruptcy does stay on your credit for 7-10 years, although you can take steps to improve your credit well before that. Remember, bankruptcy was created by Congress to help people who are overwhelmed with debt get a fresh start. You may be more productive in the long term by putting your debt problems behind you.

Related Resource

"Comparing desperate options: bankruptcy vs. debt negotiation" (Todd Ossenfort, CreditCards.com, May 3, 2010)