Pros and Cons of Filing Bankruptcy

Bankruptcy can provide relief from debt but will affect your credit score and ability to apply for credit. Learn about all the pros and cons of bankruptcy.

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You may think bankruptcy is either a disaster or a magic bullet that makes the consequences bad financial decisions disappear.

It is neither.

Bankruptcy is a legal process that allows those who have reached a financial crisis to get a second chance. It is costly, but if other debt relief options won’t work, it can be the only viable choice for those whose debts have become so large that they seem unpayable.

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 some of the debt, and the rest will be forgiven.

The purpose is to give people an opportunity to start over while protecting creditors from having to pay the entire price for bad borrowing decisions.

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 bankruptcy, the most common type of bankruptcy (69% of U.S. bankruptcy filings in 2021 were Chapter 7), 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 child support, alimony, student loans and secured debts.

For those who successfully navigate Chapter 7 bankruptcy, the process is usually over in four to six months, although it remains on your credit report for 10 years. However, not everyone qualifies. 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.

Chapter 13 bankruptcy (28% of 2021 U.S. filings) is better suited for people who are way 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 what you owe.

It’s not a quick process. You have 3-5 years to pay off your debts under the supervision of a court-appointed trustee overseeing your payments. But 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.

Before choosing Chapter 7, Chapter 13 or neither, it’s important to weigh the variables carefully.

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, much less abates. It can consume your waking hours and ruin your sleep.

The idea that you can have a fresh start through bankruptcy, and that your life may not be ruined, is worth a lot.

Here are the pros of filing 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 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 at least temporarily secured, but the creditor could go to court and receive an order that allows repossession.
  • Potential to keep some assets – Bankruptcy includes the understanding that people need to keep certain essentials 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 a 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, starting with the most obvious: Your credit score after bankruptcy is going to take a major hit – you could lose between 100 and 200 points – that won’t bounce back quickly. It remains part of your credit record for up to 10 years, which is going to make borrowing during that time more difficult and expensive (higher interest rates).

You probably knew that. If this were the only potential downside, it might be a no-brainer. But it’s not.

Here are the cons of filing 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 can’t be discharged except in rare instances, such as severe medical conditions. Student loans are one of several debts that won’t be erased by bankruptcy. Others include alimony, tax debts and child support.
  • The bankruptcy process is no picnic  Although Chapter 7 bankruptcy can be over 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 two to four years after Chapter 7, from one to three years after Chapter 13 except for FHA loans, which have no waiting periods.
  • 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 seven to 10 years, it will be less of a penalty the last 3-4 years than it was 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 about whether it’s a good idea to file for bankruptcy. It 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.

Even if none of that applies to you, consider alternatives before taking the bankruptcy step.

Debt settlement involves negotiating an agreement so that your lender accepts less than what you owe to get your debt off the books. Think lenders won’t do it? The original creditor may already have sold your account to a debt collector at a discount. So, it can’t hurt to explore this. 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 it 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 three to five years without taking out a new loan. Nonprofit credit counseling agencies offer the plans, which 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 for you.

Credit counseling is an option if your situation hasn’t become too desperate. Credit counselors provide basic financial 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. 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 more affordable to pay down your debt. This can be done through personal loans, transferring debt to a low-interest credit card, 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 bankruptcy, 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 opportunities, 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 apply to getting a handle on debt: dining out, subscriptions, gym memberships, cable, or satellite TV.

Borrowing money from family or friends risks 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.

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Talk To a Professional

Facing excessive debt is stressful, and what you do about it is a big decision. Get as much information as you can and speaking to a financial professional like a credit counselor can help clarify which alternatives are best for you. One advantage of talking to a credit counselor for bankruptcy is that if filing Chapter 7 or Chapter 13 is your best option, they can get you started with pre-bankruptcy credit counseling.

About The Author

George Morris

George Morris writes about debt relief options and bankruptcy topics for In his 40-plus-year newspaper career, George has written about just about everything -- Super Bowls, evangelists, World War II veterans and ordinary people with extraordinary tales. His work has received multiple honors from the Society of Professional Journalists, the Louisiana-Mississippi Associated Press and the Louisiana Press Association.

Article Reviewed By

Article Reviewed By

Patrick J Best - Bankruptcy Attorney

Patrick J. Best

Bankruptcy Attorney
Certified Financial Planner


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