How to Avoid Bankruptcy: 9 Alternatives to Consider Before Filing
If you’re struggling with overwhelming debt, it’s important to know how to avoid bankruptcy and its long-term impact on your credit. Filing for bankruptcy can stay on your credit report for up to 10 years, making it harder to qualify for future loans or credit cards.
Fortunately, some alternatives may provide relief, from home equity solutions to adjusting your budget. Exploring these options could help you manage your debt without the lasting consequences of bankruptcy.
| Alternative to bankruptcy | Best for those … |
| Home equity loan | With decent credit and significant equity seeking a lump sum amount for debt consolidation |
| Home equity line of credit (HELOC) | With decent credit and significant equity seeking a flexible amount for debt consolidation |
| Home equity agreement | Who understand the risks and don’t want additional payments |
| Home sale-leaseback | Who understand the risks and can afford to pay rent and fees |
| Debt consolidation | With decent credit who can qualify for a new loan |
| Debt settlement | Facing significant unsecured debt who want to reduce the total amount owed |
| Debt management plan | With multiple debts seeking lower interest rates and simplified payments |
| Earn extra income | Able to take on a side gig or sell assets to boost income |
| Reduce expenses | Able to adjust their lifestyle and cut unnecessary costs |
Home equity loan
When you take out a home equity loan, you borrow a lump sum against the hard-earned equity you’ve accumulated in your house.
You can then use those funds to pay off other high interest debt, such as credit card debt, to help you avoid filing for bankruptcy. You’ll then repay your home equity loan over a set term, which could be as long as 30 years, depending on your lender.
There are two important caveats to keep in mind:
- First, you’ll be borrowing against your home, and if you default on your home equity loan payments, your lender could foreclose on your property.
- Second, you’ll likely need decent credit (a score of 620 or higher) to qualify for a home equity loan, which could be a barrier if late or missed payments have already harmed your credit score.
Pros and cons
Pros
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Tend to have fairly low rates
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Possible to tap into a large sum if you have significant equity
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Long repayment terms may be available
Cons
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Good credit may be required to qualify
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Closing costs often required
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Lender could foreclose on your home if you default
HELOC
A home equity line of credit (HELOC) is similar to a home equity loan in that you’re borrowing against the equity you’ve accumulated in your house. But instead of receiving a lump sum loan, you get access to a credit line that you can borrow against when needed.
You could tap into a HELOC to consolidate existing debt with a set balance or to pay future uncertain costs, such as major medical bills if you have a serious health condition and require treatment.
HELOCs typically have a draw period where you can borrow against your credit line, and a repayment period where you repay what you’ve borrowed. During the draw period, which is often five to 10 years, lenders generally only require interest payments on what you’ve borrowed.
When you enter the repayment period, often up to 20 years, you’ll make full principal and interest payments on what you’ve borrowed. Again, the major drawback of using a HELOC to avoid bankruptcy is you put your home at risk if you can’t afford your HELOC payments.
Pros and cons
Pros
-
Option to borrow against credit line as needed
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Possible to tap into large sum if you have significant equity
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Long repayment terms may be available
Cons
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Good credit may be required to qualify
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Closing costs often required
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Lender could foreclose on your home if you default
Home equity agreement
A home equity agreement involves selling off a portion of your future home’s equity to an investor in exchange for a lump sum amount. You won’t need good credit to qualify, nor will you need to repay the lump sum you borrowed immediately. Instead, you must repay it when you sell your home or when the term of your agreement is up.
With many home equity sharing agreements, you also promise a portion of your future home equity to your investor. For instance, the agreement may say that you need to pay the company 10% of any future equity in your home.
Among the drawbacks of this alternative are that both the lump sum you’ve borrowed and the additional money you’ll need to pay if your equity increases could be costly and will reduce your profits if you sell your home. And, because these agreements place a lien against your home, you could end up in foreclosure if you can’t pay what you owe when it comes due.
Pros and cons
Pros
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Credit score requirements are often lower
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No monthly payments required
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No closing costs
Cons
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Large lump sum payment required when you sell or equity agreement term is up
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May reduce proceeds from your home sale
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Could put your home into foreclosure if you’re unable to repay
Home sale-leaseback
With a home sale-leaseback, an investor purchases your home, gives you the proceeds, and you lease it back from them and pay rent. You won’t be taking on additional debt and can then use those funds to pay down or consolidate high-interest debt, helping you avoid bankruptcy.
Not only does a home sale-leaseback require that you sell your home, but it also comes with other risks. A major one is that these aren’t heavily regulated, so there are fewer protections in place for you.
For instance, you could end up with exorbitantly high rent payments because the investor who purchased your home wants to maximize their profits. Investors may also charge you hefty fees if you pay late or miss payments, making it difficult to stay on track. And if you get behind significantly, they could evict you from your home.
Pros and cons
Pros
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Don’t need to take on additional debt
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Can stay in your home
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Possible to sell more quickly than a traditional home sale
Cons
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Rent payments could be hefty
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Fees often apply
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You won’t own your home or build equity with monthly payments
Debt consolidation
A personal loan, also called a debt consolidation loan, may also help you better manage your finances and potentially avoid bankruptcy. These loans generally have lower rates than credit cards, making them an option worth considering if you’re burdened by significant credit card debt.
If you can qualify for a loan like this, you can use the loan proceeds for debt consolidation, then you’ll have a single monthly payment with a lower rate. Personal loan repayment terms are often up to five or seven years.
Most personal loans are unsecured, meaning they don’t require collateral, so you’ll likely need good credit to qualify for one. This can be a big roadblock if you’re already struggling with missed or late payments and considering bankruptcy.
That said, secured personal loans exist, often requiring collateral like a savings account or vehicle, but these options aren’t as common and loan amounts may be smaller.
Pros and cons
Pros
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Often have lower rates than credit cards
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Can help you consolidate multiple payments into one
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May make it easier to pay off debt
Cons
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May need good credit to qualify
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Higher rates than home equity loans or HELOCs
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May have origination fees
Debt settlement
Debt settlement, often referred to as “debt relief,” involves negotiating with your creditors to pay less than the full amount you owe. You can attempt this on your own or work with a debt relief company, like National Debt Relief, that negotiates on your behalf. Once a settlement is reached, you’ll typically make a lump-sum payment or a series of payments to resolve the debt.
While this option can help you reduce your debt and avoid bankruptcy, it does come with risks. Settled debts can appear on your credit report as “settled for less than owed,” which can harm your credit score. Additionally, there’s no guarantee creditors will agree to settle.
Pros and cons
Pros
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Can reduce your total debt amount
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May help avoid bankruptcy
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Can resolve debts faster than making minimum payments
Cons
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Can harm your credit score
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Not all creditors will agree to settle
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May owe taxes on forgiven debt
Debt management plan (DMP)
A debt management plan (DMP) is a structured repayment program set up by a nonprofit credit counseling agency. You’ll work with a counselor to negotiate lower interest rates or monthly payments with your creditors, and you’ll make one consolidated payment to the counseling agency, which then distributes the funds to your creditors.
DMPs can simplify your payments and reduce interest rates, but they typically require closing your credit accounts. Additionally, it can take three to five years to complete a DMP, and you’ll need to stick to the plan to avoid falling back into financial trouble.
Pros and cons
Pros
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Can reduce interest rates and monthly payments
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Simplifies debt repayment into one monthly payment
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Helps avoid bankruptcy
Cons
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Requires closing your credit accounts
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Takes several years to complete
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May not be suitable for all types of debt
If you find yourself struggling with debt and need help weighing your options, consider seeking the help of a certified nonprofit credit counseling agency. They can help you take an assessment of your debt and cash flow and advise on options that are available to get you back on track.
Chloe Moore, CFP®
Earn extra income
If your debt is manageable but you’re struggling to make payments, finding ways to boost your income could help you avoid bankruptcy. This might include picking up a side gig, selling unused items, or renting out a room in your home.
While increasing your income may seem like a simple solution, it requires time, effort, and often creativity. Additionally, depending on your situation, it may not provide the immediate relief you need if your debt burden is overwhelming.
Pros and cons
Pros
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Can provide extra funds to pay down debt
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Avoids taking on additional debt
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May be easier for some borrowers to implement
Cons
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May not provide immediate relief
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Requires time and effort
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Some income-boosting strategies may have tax implications
Reduce expenses
Cutting unnecessary expenses can free up funds to put toward your debt payments. Start by reviewing your budget and identifying areas where you can trim costs—such as canceling subscriptions, dining out less, or negotiating lower rates for bills.
Reducing expenses is a practical way to improve your financial situation, but it may not be enough to address significant debt on its own. It’s most effective when combined with other strategies, like earning extra income or negotiating with creditors.
Pros and cons
Pros
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Frees up funds to pay down debt
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Avoids taking on new debt
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Easy to start immediately
Cons
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May not be enough to address significant debt
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Requires lifestyle changes
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Can feel restrictive over time
If you’re in a situation where you are considering bankruptcy, it’s important to explore how you got here. If you can’t change the behaviors and habits that got you into debt, some of these alternatives could put you in a worse position, especially the ones leveraging your home equity.
Chloe Moore, CFP®
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