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Bankruptcy is considered a second chance for people who can’t recover from the one-two punch of high credit card balances and punishing credit card interest rates.
The average credit card balance in the U.S. in 2024 was $6,295, an increase of nearly $500 in a year’s time. According to the Federal Reserve, the average credit card interest rate on balances in 2023 was 22.75%, so it’s easy to see how debt can skyrocket and prompt consumers to take desperate measures.
One person’s definition of struggling with debt could be someone else’s definition of drowning in it, especially if the latter is among the 60% who file for bankruptcy with an income under $30,000.
Try paying off your credit cards while taking home less than $500 a week.
“The vast majority of people who file bankruptcy are there because they really need it,’ said Edward Janger, who teaches and writes about bankruptcy at Brooklyn Law School. “They don’t get into it because they think it’s going to be fun and easy. They’re struggling and bankruptcy lets them hit the reset button.”
The goal of bankruptcy is to wipe out personal liability for debt. And that goal is well within reach. In the case of Chapter 7 filings, the success rate for discharging unsecured debts (like credit cards) is an astounding 96.8% but there are significant drawbacks to consider before filing.
Not everyone qualifies for Chapter 7 or Chapter 13 bankruptcy and there are repercussions for having credit card debt discharged. There’s a negative stamp on your credit report for 7-10 years. And if your financial life goes haywire again, you can’t file for eight years.
Janger, who graduated from Yale and got his law degree at the University of Chicago, suggested anyone considering bankruptcy review those consequences.
“Filing bankruptcy isn’t something to take lightly,” he said. “There have been plenty of studies that show that people choosing this do so because they’re in deep trouble and this gives them a way out.
“But the cost is you’re going to have trouble getting credit for the next 10 years and if you do, it’s going to be very expensive. That means you’ve got to live on cash and wait until the bankruptcy works its way off your credit report.”
So, should you file for bankruptcy to eliminate credit card debt? If your goal is to get a restart on your finances, bankruptcy can do that. Just know the financial consequences of making that choice.
Falling Behind on Credit Card Payments
The road to bankruptcy via credit card debt is easy to trace. It starts by skipping one monthly payment on your credit cards, then finding a late fee slapped on your bill the next month. The next step is to miss payments for two consecutive months. Do that and the Credit Card Act of 2009 permits card companies to raise the interest rate on your card.
They also can raise the interest rate if:
- Your credit score goes down
- You own the card for more than one year
- The prime interest rate increases
- The promotional introductory period ends
It’s not uncommon for someone missing payments to see their interest rate jump from the national average of 21.59 to 30%. In fact, there is no law preventing card companies from going even higher. Even those consumers with “excellent” credit ratings pay 18% on average.
When the interest rate jumps – and late payment penalties and over-the-limit charges compound the problem – your credit card debt soars. If you stop making even minimum payments, that’s when the debt collection agencies arrive.
Debt collectors are notoriously aggressive in pursuing credit card debt. Their lawyers can sue and obtain judgments that include garnished wages and property liens.
Filing for bankruptcy can stop the lawsuits and collection agencies. It’s called an automatic stay, and it prevents creditors from starting or continuing action against you to collect the debt. It is one of the definite positives for filing bankruptcy.
Chapter 7 Bankruptcy for Credit Card Debt
Filing Chapter 7 bankruptcy can wipe out credit card debt and sweep all forms of unsecured debt into the garbage, if done properly. Among the bills that can go away are:
- Medical
- Utility
- Personal loans
- Back rent
- Phone
- Deficiency balances due to repossession
There are debts that you can’t wipe out with Chapter 7, including child support, alimony, taxes, student loans, legal judgments and debt obtained through fraud.
Remember that any non-exempt property you own, which typically would include a second house or car, jewelry, art and other non-essential “luxury items” will be sold by the bankruptcy trustee and proceeds turned over to the creditors involved in your case, including the card companies.
Exceptions for Eliminating Debt with Chapter 7 Bankruptcy
While there are plenty of reasons to eliminate credit card debt through Chapter 7 bankruptcy, there are two major reasons you would not have the debt successfully discharged:
- You incurred debt on your credit card as the result of fraud.
- You used the credit card to purchase property that the creditor has a security interest in, such as a high-end appliance or piece of jewelry.
The issue of fraud could be the result of you making false statements that allowed you to get the credit card in the first place. For example, over-stating your income on your application; or possibly doctoring or counterfeiting a credit card to make purchases.
It also is considered fraud when you use the credit card to make “luxury” purchases of more than $725 or take a cash advance of more than $1,000 within 70 days of filing bankruptcy. In other words, if you know you’re going to file bankruptcy, don’t go running up tabs on your credit card.
The second reason is rare but could result in purchases you made being repossessed. If creditors see that you bought a top-of-the-line appliance or living room furniture or gold and diamond jewelry, that could be considered secured debt. They could call it “collateral” and ask for it to be sold.
The debts for these purchases can be wiped out, but you won’t be permitted to keep the property.
The Bankruptcy Filing Process: Chapter 7
Filing for bankruptcy isn’t something you should take on yourself even if the temptation to save money is as strong as it is for a DIY home renovation.
The necessary paperwork alone recommends hiring a bankruptcy attorney. There’s peace of mind that comes with getting help navigating a bankruptcy filing process that includes nonprofit credit counseling in the previous 180 days and extensive documentation of assets, income, and debts.
Once the paperwork is filed, the court appoints a trustee who arranges a meeting of creditors. You are required to answer questions from the trustee and creditors about the debts you are claiming and the paperwork you’ve filed.
Eligibility for Chapter 7 bankruptcy requires you pass a means test comparing your income and debts owed to the median income in your state. If you are declared eligible for Chapter 7, you must then complete a financial education course from a nonprofit credit counseling agency before your case can be discharged.
A Chapter 7 bankruptcy filing typically is resolved within six months, at which time eligible debts are forgiven. Chapter 7 will stay on your credit report for 10 years.
Chapter 13 Bankruptcy for Credit Card Debt
Chapter 13 bankruptcy is called “reorganization” and unsecured debt, like credit cards, is given a very low priority in the reorganization.
When you file for Chapter 13 bankruptcy, you submit a plan to the bankruptcy trustee that says you will pay most, if not all, of what you owe in 3-5 years. The next step is to prioritize the debts, starting at the top with secured debts (home, car), and priority debts (child support, alimony, or back taxes).
Unsecured debt, like credit cards, is at the bottom of the priority list.
The Chapter 13 filer then looks at his current and future income and determines how much will go to repay debts in a 3-5 year period. Very little, if any, is set aside for credit card debt.
If the bankruptcy trustee agrees with the plan, and the consumer makes the required payments, all debts are discharged, including credit card debt, when the final payment is made.
Because Chapter 13 bankruptcy does not put much emphasis on repaying unsecured debt, it’s likely most or all of what you owe on credit cards will disappear with a successful discharge.
The Bankruptcy Filing Process: Chapter 13
The process of filing Chapter 13 is similar to filing Chapter 7 in that nonprofit credit counseling is required, as is a meeting with your bankruptcy trustee and creditors and the completion of a financial education course.
Filing Chapter 13 bankruptcy is viewed more favorably than Chapter 7 because you will be paying back some or all of your debt. The biggest difference between the two filings is that in Chapter 13 the court must approve a repayment plan that is based on income and non-exempt property values.
The process includes strict deadlines for paperwork filing and extensive documentation of assets, income, and debt. A bankruptcy attorney can provide crucial help in meeting those deadlines and ensuring an accurate filing that meets court standards.
Chapter 13 bankruptcy filers typically begin their repayment plans within 30 days of court approval. Most successful repayment plans are completed within three-to-five years during which individuals get protection from creditors.
Upon completion of the repayment plan, your bankruptcy case is closed. though Chapter 13 bankruptcy will remain on your credit report for seven years.
Filing Bankruptcy on Credit Cards Only
Filing for bankruptcy just to eliminate credit card debt is not practical for one reason: You must include all debts when you file bankruptcy. That’s true whether you’re filing Chapter 7 or Chapter 13.
So, if you had no other debts, there are better options for paying off credit card debt, like debt management or debt settlement programs, that wouldn’t be as drastic or have as much negative impact as bankruptcy.
Qualifications for Filing Bankruptcy for Credit Card Debt
Qualifying standards for filing Chapter 7 or Chapter 13 bankruptcy are intended to determine whether a consumer is capable of managing the debt themselves. People wanting to file Chapter 7 bankruptcy must pass a “means test” and those trying to file Chapter 13 have strict amounts of debt they can’t exceed.
The means test for Chapter 7 involves two considerations. You can pass the test if your income over the previous six months is under the median income for your family size in your home state. The majority of Chapter 7 filers pass the means test this way.
If you don’t, then you move on to the second consideration: Is there enough income left over to pay down your debt, after deducting expenses for essential items like housing, food, clothing, transportation, utilities, etc.
If there is enough money left, you will be dismissed from Chapter 7 and referred to Chapter 13. If there isn’t enough money left over, you may qualify for Chapter 7.
In Chapter 13, the qualifying debt amount for an individual can’t exceed $419,275 for unsecured bills (credit cards, student loans) and $1.257 million for secured debt (home, car). Be careful with both categories of debt. If you have fallen behind on payments, your totals may exceed the allowed amount.
Can Credit Card Companies Sue Me After I File for Bankruptcy?
When you file for bankruptcy, the “automatic stay” protection goes into effect and prevents credit card companies from initiating or continuing a suit against you to collect money.
If the credit card company filed a debt collection lawsuit against you before you filed, — and the case hasn’t been settled – the lawsuit can’t proceed while the automatic stay is in effect, unless the bankruptcy court gives the card company permission.
If you do receive a discharge in Chapter 7, most often that will include discharge of judgments from debt collection lawsuits.
Alternatives to Bankruptcy
As tempting as it is to hit the reset button on your debts, bankruptcy is a scarlet letter on your credit report.
Managing credit card debt is daunting for many people but it can often be managed without filing Chapter 7 or Chapter 13. Individuals facing overwhelming credit card debt should first explore all available alternatives:
- Nonprofit credit counseling can help you make an informed (and unemotional) decision about your debt and propose options you might not know even existed. Credit counselors can help with everything from family budgeting to debt workshops to debt management plans.
- Debt management can be a smart option. After analyzing your finances, in a debt management plan (DMP) nonprofit credit counseling agencies have agreements with creditors to lower interest rates. You then make a single monthly payment to a credit counseling agency which distributes the payment to your creditors. With consistent monthly payments, credit scores will improve over the course of the DMP.
- Debt settlement is a negotiation with creditors but there are more downsides. First, debt settlement often requires a lump sum payment. It also could negatively impact your credit score and stay on your credit report for seven years.
- Loans from family and friends could help pay off credit card debt but make sure to agree on repayment terms (preferably in writing) so there are no hard feelings.
- Debt consolidation loans are another option that often offers a lower interest rate (if you have reasonably good credit) than you’re paying on credit cards. But it doesn’t a