The Pros and Cons of Filing for Bankruptcy

Bankruptcy is a legal process in which a person or business declares they can’t repay their debts and wants a second chance to resolve their financial crisis.

The process can be costly, but if other debt relief options won’t work, bankruptcy might be the only viable option for those whose debts have become unmanageable.

When you file for bankruptcy, a court examines your assets and liabilities and determines whether you have enough assets to pay what you owe. If you can, your case may be dismissed. If not, some of your assets will be used to pay part of the debt, and the rest will be forgiven. And in one bankruptcy filing, if you can pay your debts over time, the court will set up a payment plan.

The purpose of bankruptcy is to give people an opportunity to start over while protecting creditors from having to pay the entire price for a borrower’s bad decisions.

Before choosing any kind of bankruptcy, it’s important to understand the process and weigh the pros and cons carefully.

How Filing for Bankruptcy Works

There are several types of bankruptcy in federal law that apply to individuals, businesses, and even municipalities. For most individuals, there are just two choices: Chapter 7 and Chapter 13.

Chapter 7 bankruptcy, the most common type of personal bankruptcy (62.9% of U.S. nonbusiness bankruptcy filings in 2024 were Chapter 7). It involves certain assets being liquidated to settle all or part of your debts. Some essential items dealing with home and work are exempt.

Chapter 7 covers unsecured debts such as credit cards or personal loans, as well as medical bills, utility bills, and civil court judgments that aren’t based on fraud. However, it will not eliminate debts involving child support, alimony, student loans and secured debts.

For those who successfully navigate Chapter 7 bankruptcy, the process is usually over in 4-6 months. However, it remains in your credit report for 10 years. Not everyone qualifies for Chapter 7 bankruptcy. If the court determines you have enough income and assets to eventually pay what you owe, it’s unlikely to allow a Chapter 7 bankruptcy.

To help in your research, consider taking the free Chapter 7 calculator below to estimate whether you may qualify for Chapter 7 bankruptcy and an estimated all-in cost.

» Learn More: Pros and Cons of Chapter 7 Bankruptcy

Chapter 13 bankruptcy (39.9% of 2024 U.S. nonbusiness filings) is better suited for people who are behind on their debts but have the income and assets to pay them with a little help. In Chapter 13, debts are reorganized, and you’re put on a program to pay those debts.

You have 3-5 years to pay off your debts under the supervision of a court-appointed trustee overseeing your payments. The plan may keep you from having your house foreclosed or your car repossessed. If you have a steady income, haven’t recently filed for another bankruptcy and are current on your taxes, Chapter 13 may work for you.

Pros of Filing for Bankruptcy

One of the biggest advantages of bankruptcy may be the least tangible – the feeling that you can breathe again. Having your financial world collapse can create pressure that never ceases. It can consume waking hours and ruin sleep.

The idea that you receive a fresh start through bankruptcy, and that your life may not be ruined, is a stress relief.

Here are the pros of filing for bankruptcy:

• Stop foreclosure – When you file a Chapter 13 bankruptcy, foreclosure proceedings against your home are halted while a payment plan is developed to get you caught up on mortgage payments, including what’s past due. Another option is that the homeowner may decide to sell the house so the lender can receive what’s owed and the homeowner can keep any extra money the sale produces.
• Automatic stay – In both Chapter 7 and Chapter 13 bankruptcies, all creditors and collection agencies must temporarily stop harassing you with phone calls, letters, and the threat of lawsuits until the bankruptcy case is closed. That gives debtors the opportunity to solidify their finances before collection attempts can resume.
• Prevent car repossession – By filing for Chapter 13 bankruptcy and making the car part of the court-approved repayment plan, creditors may not repossess the car. In Chapter 7 bankruptcy, the car is often exempt, especially if you need it to go to and from work or for the family.
• Potential to keep some assets – Bankruptcy includes the understanding that people need to keep certain essential items to be a productive part of society. In fact, according to the American Bankruptcy Institute, 96% of Chapter 7 cases were deemed “no asset” meaning there is not enough equity or value in the property for a trustee to sell and pay off creditors. Bankruptcy exemptions prevent certain items from being taken and sold to pay back the creditors. Which items are exempt depends in part on the state where you live. You may keep your car up to a certain value if you need the vehicle to keep working. If your vehicle is worth more than what your state considers to be exempt, it can be sold to pay creditors, but you receive the amount of the exemption in cash. Assets like veterans’ benefits, unemployment benefits and retirement accounts also may be exempt from bankruptcy.
• You’ll likely end up paying less than you owe – This is especially true in Chapter 7 bankruptcy, which potentially wipes out all your unsecured debt. Chapter 13 requires repayment of at least some of what you owe.
• Bankruptcy decisions are final – Once creditors agree to a deal, they can’t change their minds and ask for more.
• The court appoints a representative for you – That trustee works on your behalf and handles all contact with your creditors.

Cons of Filing for Bankruptcy

There are, of course, disadvantages to filing for bankruptcy. Let’s start with the most obvious: Your credit score after bankruptcy is going to take a major hit – a decrease of between 100 and 200 points – and it won’t bounce back quickly.

Bankruptcy remains part of your credit record for up to 10 years, which is going to make borrowing during that time more difficult and expensive because lenders will charge higher interest rates.

This is not the only potential downside, though.

Here are the cons of filing for bankruptcy:

• The cost of filing bankruptcy – It may seem like adding insult to injury, but it’s going to cost you money to go through bankruptcy. The filing fees alone are more than $300. Attorney fees can range from $1,000 to $3,500 for Chapter 7 and $2,500 to $6,000 for Chapter 13, depending on where you live and the complexity of the case.
• Most student loans are exempt from bankruptcy – Unlike many debts, federal student loans are not automatically discharged in bankruptcy. To have them discharged in the proceedings, you must take extra steps – like proving that paying them would cause “undue hardship.” Other debts not erased by bankruptcy include alimony, tax debts and child support.
• The bankruptcy process is no picnic – Although Chapter 7 bankruptcy can end in 4-6 months, Chapter 13 lasts 3-5 years. During that time, much of what you earn will automatically go to repay your creditors, so your lifestyle will take a hit.
• Purchasing a home after bankruptcy is challenging – Even after your bankruptcy case is discharged, there are waiting periods before you can apply for a mortgage: from 2-4 years after Chapter 7, from one month to three years after Chapter 13.
• Buying a car after bankruptcy – It’s possible to get a car loan, but expect the interest rate to be higher. The longer you can wait while rebuilding your creditworthiness, the better deal you can get. Although the bankruptcy shows up on your credit report for 7-10 years, it will be less of a penalty in the last 3-4 years than it was in the first few.
• Difficulty renting – Management companies and landlords may refuse to rent to those who have gone through bankruptcy.
• Career prospects – In some fields, bankruptcy can disqualify you from jobs where you might be considered a security risk.
• Embarrassment – Bankruptcies are public record, so your friends and co-workers may find out.

Should You Declare Bankruptcy?

Because there are so many consequences of filing bankruptcy, there’s no one-size-fits-all answer to deciding whether to file. Bankruptcy should be considered a last resort because the consequences are significant and long-lasting.

Also, some actions essentially disqualify people from successfully seeking bankruptcy. If you’ve tried to game the system by taking out credit cards under different Social Security numbers, have been accused of intentionally defrauding creditors, recently transferred your home, car, and possessions to a relative or are about to inherit significant assets like a house or a lot of money, bankruptcy isn’t for you.

As mentioned above, student loans usually can’t be discharged through bankruptcy, either.

Alternatives to Bankruptcy

Because bankruptcy is a last resort, it’s wise to consider every alternative step available before filing.

Debt settlement involves negotiating an agreement so that your lender accepts less than what you owe to get your debt off the books. Look for a debt settlement company associated with the American Fair Credit Council that can help determine how much you can settle for and how long it will take. It’s not a quick fix. Creditors aren’t required to agree to settlement offers and your credit score will still take a hit. But you’ll pay less than you owe and avoid the worst consequences of bankruptcy.

Debt management programs enable you to pay off unsecured debt like credit cards in 3-5 years without taking out a new loan. Nonprofit credit counseling agencies offer plans that reduce the interest rate on credit card debt. The agencies create a monthly budget for you that includes a fixed, affordable payment to the credit card companies. If the creditors approve the plan, you make one monthly payment to cover all of the card debt, which simplifies the process.

Credit counseling is an option if your situation hasn’t become too desperate. Credit counselors provide basic financial advice about money management and budgeting to help you avoid bankruptcy. They educate consumers on what causes debt, how to avoid borrowing more than you can manage and how to live on less than what you earn. They also help you ask creditors about a settlement or payment plan. Credit counselors tailor a plan that fits your specific situation.

Debt consolidation moves multiple credit card bills into a single monthly payment. There are two forms: debt management programs (see above) or debt consolidation loans. The goal in both is the same: reduce multiple debts to a single monthly payment to a single source and reduce the interest rate charged on the debt. To get a debt consolidation loan, you need a steady income source and a decent credit score (670 or higher) so you can get an interest rate low enough to make it affordable to pay down your debt. This can be done through personal loans, transferring debt to a low-interest credit card, a home equity loan or a loan against your 401K account.

Selling some of your assets to increase your debt payments might help you avoid bankruptcy. That’s especially worth considering if you’re headed toward Chapter 7, which may require such liquidation. Naturally, you should keep assets that are essential to running a business or earning a living.

Earning extra income may be enough to avoid bankruptcy if you use the additional money to pay down your debts. Whether it’s driving for a ride-sharing company, a delivery or shopping service or work-from-home jobs, there are a lot of part-time work opportunities.

Restructuring or refinancing your mortgage may free up money you can apply to other debts.

Cutting expenses is another option. If you haven’t made a budget, creating one may show you expenses that you can live without and can help to get a handle on debt. Things like dining out, subscriptions, gym memberships, cable, or satellite TV can be cut back or eliminated to free up money to pay down debt.

Borrowing money from family or friends could risk damaging relationships, but as a last resort to avoid bankruptcy, it’s worth considering. If you take this route, make it a written agreement, set a payback schedule, and follow it consistently.

» Learn More:

• Bankruptcy vs. Debt Settlement
• Bankruptcy vs. Credit Counseling

What Happens When You File for Bankruptcy?

Filing for bankruptcy starts the process of digging yourself out of debt. The filing immediately enacts the automatic stay, which stops all actions by creditors – including legal actions, phone calls and garnishing of wages.

A trustee will be appointed who will go over your income, expenses, and assets. If you filed Chapter 7, you may need to sell some assets (not your home or car if you need it for work) to repay part of your debt. With Chapter 7, some debts may even be discharged. If you file Chapter 13, you and the court will work out a payment plan to pay off your debts. This process will take 3-5 years.

The best day in the process comes when bankruptcy is discharged. That means you have lived up to your obligations after filing, and you are free from the legal obligations. At this point, you should make sure going forward that you spend wisely and repay any debt (especially credit cards) in full and on time.

Talk to a Professional Before You File

It’s always wise to consult a professional before filing for bankruptcy. The first step could be to discuss your situation with a nonprofit credit counselor. These counselors can find the right solution for your situation and may help avoid bankruptcy.

The next step would be to consult with a bankruptcy attorney. As much as we might not want to pay an attorney, the bankruptcy process is daunting. It’s wise to have someone who knows the intricacies on your side. The first meeting with a bankruptcy attorney is usually free, so spending an hour discussing your situation is an hour well spent.

Attorneys will be able to answer almost any question you have about the process and will advise the best ways to proceed. He or she will also break down the process, thus eliminating the unknown and easing the fear.