What Are the Consequences of Bankruptcy?

The consequences of filing for bankruptcy are both good and bad. Find out which assets you may be forced to liquidate, who can find out about your bankruptcy and how long it will take your credit score to rebound.

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Filing for bankruptcy can be a scary thought, in part because the fallout from filing is significant.

However, if bankruptcy is necessary and is managed properly, it can offer short-term pain for long-term gain.

“A personal bankruptcy can reduce or eliminate debt,” said Matthew Salerno, who teaches a bankruptcy course at Case Western Reserve University Law School. “But there are also some potentially negative consequences to consider.”
Some of the negative consequences include:

  • Not all debts may be discharged.
  • Non-exempt assets could be sold with the proceeds used to pay debt.
  • Those who own luxury possessions probably will lose them.
  • Bankruptcy remains on a credit report for 7-10 years and may affect the filer’s ability to borrow in the future.
  • Your credit score will plummet 100-200 points.

“Bankruptcy (also) is a matter of public record, so your information is visible to family, friends, employers, and others,” Salerno said. “To some, there is a negative stigma associated with a bankruptcy filing and this can have an emotional impact on the bankruptcy filer.”

The first decision you’ll face is deciding if you should file bankruptcy. The second is which type of bankruptcy suits you. Almost 98% of bankruptcy filings are Chapter 7 or Chapter 13.

Chapter 7 is called “liquidation bankruptcy,” which means selling your non-essential assets and using that money to pay debt. There were 242,936 Chapter 7 filings in 2023, according to the American Bankruptcy Institute (ABI). The process in Chapter 7 usually takes 3-5 months before discharge.

Chapter 13 is called “wage earner’s bankruptcy,” meaning you have enough income to formulate a plan to pay off some or all of your creditors in 3-5 years. There were 175,964 Chapter 13 filings in 2023. In Chapter 13, your assets are not sold, but you must stick to a court-mandated repayment plan that your creditors also have agreed to.

To be eligible for Chapter 13, you cannot have more than $465,275 in unsecured debt (credit cards, medical bills, student loans) and $1,395,875 in secured debt (mortgage, car loans).

If you’re ineligible for Chapter 13, you may be able to file under Chapter 11 bankruptcy, which is called a “reorganization bankruptcy.” Chapter 11 represents less than 1% of filings and is mostly used by businesses.

With that in mind, let’s focus where 98% of filings are and answer the most common questions about Chapter 7 and 13.

Loss of Property

Loss of property is one of the main consequences of bankruptcy.

This loss could include non-essential holdings – a second home, cars, jewelry, antiques, and other valuable personal possessions not necessary for your work or day-to-day existence.

In Chapter 7, some personal assets are exempt from bankruptcy proceedings. Generally, your residence, car, clothing, necessary items for work, public benefits, retirement accounts and spousal or child support are considered exempt in Chapter 7 bankruptcy filings.

Concerns over losing vital property weigh heavily on filers.

“The answer is not always simple,” Salerno said “and it requires careful consideration of what assets might be at risk in the bankruptcy case. Many people, however, do not lose assets in individual bankruptcy cases.

“Certain exemptions exist under state and federal law that are meant to allow individuals to keep what they need to live and to work and, hopefully, to recover financially. The amount of exemption and the kind of property you can claim as exempt varies from state to state, but if property is exempt, then you will likely be able to keep it.”

The good news is that more than 90% of those who file Chapter 7 are able to keep all of their property, according to the American Bankruptcy Institute. The idea is that people need to keep working and be in their home to repay debt, so it makes no sense to force them out.

Each state has standards for bankruptcy exemptions. Ohio, for instance, allows an exemption of up to $161,373 in equity in your home, up to $4,450 in a car and up to $550 of cash on hand or in a bank. The state of Washington allows home exemptions of between $207,100 and $914,300, depending on where the home is located.

Personal property in Chapter 7 that may have to be sold includes a second home, a boat, an extra car, jewelry, or antiques – anything that is not essential to your work and life.

In Chapter 13, the Court allows you to keep your property and assets, but you must repay your debt faithfully in monthly payments over a 3-5 year time period.

Impact on Co-signers

Bankruptcy can impact anyone who helped you borrow money by co-signing for a loan or credit card. If your parents co-signed a car loan, they will be responsible for some of that debt if you file bankruptcy.

Chapter 7 usually is harsher for co-signers. The person who files bankruptcy has an automatic stay placed on debts, meaning those debts cannot be collected while the stay is active. Co-signers, though, do not receive that stay and could be chased by the debtor.

In Chapter 13, co-signers receive that stay, making this type of filing much less painful for the parent or friend who helped. Making the monthly Chapter 13 payments properly and on time is vital. If you don’t, creditors could hound you and the co-signer.

Here are steps you could take to protect co-signers on loans, who often are close friends or relatives:

  • Reaffirm debt. This means affirming you will still be responsible for the debt after a bankruptcy case ends, which means you and not the co-signer repay it.
  • Continue paying the debt after discharge. This will protect co-signers from being liable for the debt.
  • Look carefully at Chapter 13. Automatic stays granted to the borrower and co-signer protect the co-signer.

Credit Damage

Bankruptcy may be the most significant negative impact on your credit report for several years. This is because by filing you have shown you have not paid debts responsibly – even if it is because of bad luck (lost job) or medical emergencies.

The impact on your credit score is harsh. If you enter bankruptcy with an average-to-good score (680-to-780), your score could drop between 150 and 240 points.

Chapter 7 filings stay on a credit report for 10 years.

A Chapter 13 bankruptcy stays on a credit report for up to seven years.

By law, once those timeframes expire, the bankruptcy comes off the credit report. There’s very little you can do except be patient and pay debts responsibly while bankruptcy is on the credit report.

Bankruptcy on a credit report can affect borrowing, and will be seen by banks, businesses, potential employers, and lenders.

What can you do to ease the impact?

  • Make sure debts forgiven in bankruptcy are marked as discharged on your credit report. This shows you’re clear and moving forward.
  • Check your report, and if there are mistakes, ask the agency to fix them.
  • Make payments on time and in full.
  • Use credits cards wisely and stop spontaneous and luxury spending. If the home needs a new water heater, that’s essential. A new home entertainment system is not.
  • Emphasize savings. Setting aside money for an emergency fund means it will be there if you need it.

When Will My Credit Score Rebound?

FICO, which calculates credit scores for 90% of lenders, estimates it takes about five years for a score that was 680 to fully recover from a bankruptcy filing.

Just about everybody who files for bankruptcy ends up with a credit score south of 600, some of them way south. A good credit score (700 or higher) will likely drop more than 200 points after bankruptcy. A lower score will drop between 130 and 150 points.

The fact that bankruptcy stays on your credit report for 7-10  years can mean paying higher interest rates on loans, assuming you’d qualify.

Filers can rebuild credit over time by managing debt smartly. The best place to start is by making on-time payments and bringing past due accounts up to date. That is the biggest factor in a credit score.

The impact of bankruptcy lessens over time because some of your debt is reduced or discharged. That reduces credit utilization ratio, which determines 30% of your credit score.

Tax Refund

One of the consequences of bankruptcy will be that you may not be able to keep your tax refund. That’s because the refund will be looked on as a way to help pay debts.

Tax returns are handled differently in Chapter 7 and Chapter 13. In Chapter 7, you could lose some or all of the refund one time. In Chapter 13, the Court may want some of the money every year until terms of the payment plan are met.

If you file Chapter 7, you may lose the refund if it was earned before discharge. Some or all of that money could pay debt. A refund from income earned after a Chapter 7 bankruptcy discharge remains yours.

In Chapter 13, some or all of the refund could be applied to payments toward debt. This will depend on the plan set up by the Court, and it could vary from state to state or even case to case.

An option for keeping the tax refund in Chapter 7 would be to have it considered a “wildcard” exemption. This must be claimed through the Court. Federal law limits the wildcard exemption to $1,475.

With Chapter 13, the Court allows you to keep enough money to live and pay necessary expenses – utilities, car payment, mortgage, etc. Excess goes to pay debt. Because the tax refund is considered excess, the Court likely will lean toward applying it to paying debt. You could keep the tax refund if you face an emergency, though that may require seeking a plan modification.

One thing not to do: Do not use the tax refund to buy a luxury item prior to filing. The Bankruptcy Court will not look kindly on that spending. If you file your tax return early and a refund arrives before filing, use it to pay down debt or to pay necessary expenses.

Social Stigma

Filing for bankruptcy may bring mental health challenges while you navigate your way through a painful process.

Even bankruptcy attorneys understand that the mental and personal toll from filing is a challenge. It could affect your self-image, and your sense of worth.

If you are in the position where you need to file, it’s important to remember the long game. Once your bankruptcy is discharged, the financial house should be in order, which will make the rest of life easier.

Focusing on the end result could make the short-term pain more tolerable.

In addition, looking at bankruptcy as a solution and not a problem may help. Filing means taking steps to solve a debt problem that has become onerous.

What To Do Before Filing for Bankruptcy

Concrete steps may be taken before filing that may lessen the emotional and financial pain of bankruptcy.

Prior to filing, it’s always wise to:

  • File tax returns.
  • Avoid new debt.
  • Gather all documents and information, including debt, income, and communication with creditors.
  • Attend a mandated credit counseling session 180 days before filing.
  • Fill out the forms properly and completely and pay the filing fee ($335 for Chapter 7, $310 for Chapter 13).

If you wish to take steps to avoid filing, you could try selling assets to pay off debt. This puts control of what you sell in your hands, and not the Court’s.

You also could try negotiating with creditors, who may be willing to work out an agreement that will help. Creditors could be motivated to help because they know that they likely will get more money back this way than they may through bankruptcy.

It also could help to have your own personal credit counseling session with a nonprofit counselor, who may be able to find a way through the financial challenges without filing for bankruptcy. These counselors offer free sessions, and because they are nonprofit, are bound by law to offer the best solution for your situation.

Bankruptcy is a last resort, but if it’s necessary it’s always wise to consult with an experienced bankruptcy attorney who can help you navigate through the system.

Should You File for Chapter 13 or Chapter 7?

 Obviously, the ideal answer is neither, but sometimes bankruptcy is unavoidable in the wake of medical emergencies or job loss.

If you want to be able to keep all of your property and personal items, Chapter 13 might be your best bet, but there are cons to Chapter 13 bankruptcy as well. Chapter 7 has harsher consequences, but it might deliver the financial relief you need.

Chapter 7 also has a means test, which is designed to ensure the debtor truly cannot repay debt with his or her income. If the filer makes more than the means test allows, he or she fails the test, and the only option is Chapter 13.

In the means test, income from the previous six months before filing is considered. The threshold is the census bureau’s median income for the family size in the state where bankruptcy is filed.

The right option clearly depends on individual circumstances.

“Bankruptcy is complex,” Salerno said. “Deciding whether to file a personal bankruptcy and what type of bankruptcy to file are serious considerations. It is worth thinking carefully about hiring an experienced bankruptcy attorney to help with what can be a difficult and complicated process.”

Bankruptcy Alternatives

It’s wise to consider options that may help avoid filing. As we already stated, negotiating with creditors may lead to a solution. It’s important to know that you must strictly adhere to the terms of any agreement reached with a creditor.

Debt could be paid off with income from a second job or gig work, like delivering meals through Door Dash or something similar. Savings or a home equity loan could be used to pay debt.

An individual could consider a debt management plan through a nonprofit credit counselor. This plan reduces the interest rate on credit card debt to somewhere around 8% and gives you 3-to-5 years to pay off that debt, with a lower monthly payment. The savings can be significant and could help eliminate debt faster if it is applied to that debt.

Taking a debt consolidation loan means combining all debt into one loan, which is used to pay off all those debts. Making one payment is simpler but requires good credit to receive a good interest rate, and anyone considering bankruptcy may not have the credit score to qualify for a consolidation loan.

A session with a nonprofit credit counselor could help assess options other than bankruptcy and find the best approach for each personal situation.

About The Author

Bill Fay

Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it in 2012, helping birth Debt.org into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering the high finance world of college and professional sports for major publications, including the Associated Press, New York Times and Sports Illustrated. His interest in sports has waned some, but he is as passionate as ever about not reaching for his wallet. Bill can be reached at [email protected].

Article Reviewed By

Article Reviewed By

Patrick J Best - Bankruptcy Attorney

Patrick J. Best

Bankruptcy Attorney
Certified Financial Planner


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