In times of financial difficulty, individuals may find themselves grappling with the best way to manage overwhelming debt.

Two common strategies to address severe financial distress are debt bankruptcy and restructuring. Each option has its benefits and drawbacks, and understanding them can help you make an informed decision and create a path forward.

Bankruptcy

Bankruptcy is a legal process that provides relief to people who are unable to repay their debts. There are different types of the US Bankruptcy Code, with Chapter 7 and Chapter 13 being the most common for individuals. Chapter 7 is also known as liquidation bankruptcy and involves selling nonexempt assets to repay creditors for unsecured debts like credit cards, and personal loans. After all assets are sold, most types of remaining debt is discharged, which can provide some immediate financial relief. However, this type of bankruptcy can stay on your credit report for up to ten years, impacting your ability to obtain new lines of credit in the future.

On the other hand, Chapter 13 bankruptcy, also known as reorganization, allows you to keep your assets and repay your secured debts through your disposable income, such as for a car loan or mortgage, over a three-to-five-year period under a court-approved repayment plan. Once the repayment period is over, some of the leftover debts may be discharged, though it is not a guarantee due to the complexity of the law. The bankruptcy also stays on your credit report for up to seven years.

Debt restructuring

Debt restructuring involves working with your creditors to modify the terms of an existing debt, such as a credit card, student loan, car loan, or mortgage. This may mean extending the repayment period, reducing the interest rate, or lowering the total amount owed. Since debt is often a result of financial hardships, it is generally the last step before filing for bankruptcy.

If you’re able to agree on renegotiated terms, your payments should become more manageable, helping you to avoid defaulting on a loan, which could have a significant impact on your credit score and financial well-being. And unlike bankruptcy, debt restructuring usually allows you to keep your assets while paying off your debt.

However, although it is less severe than bankruptcy, debt restructuring can still hurt your credit score, especially if you don’t make payments while you’re negotiating with creditors, which can take a long time depending on the amount of debt you have. Furthermore, the debts are not discharged, meaning you’re still responsible for paying off your loans. So if the underlying financial issues aren’t addressed, you could still face problems in the future.

Because of this, debt restructuring is typically suitable for those who are facing temporary financial difficulties but expect their situation to improve. However, bankruptcy may be the best option if you are unable to meet your financial obligations and other debt-relief methods have failed. It can provide a fresh start, but it should be considered carefully due to its long-term consequences.

If this sounds like a lot to consider, you’re right—and you don’t have to go it alone. Before making any decisions, consider talking with a qualified financial professional, who can help examine your situation and determine the best option for you.