If you’re considering bankruptcy, it means you have serious debt. Bankruptcy can be an opportunity to rebuild finances, but it comes with a serious long-term hit to your credit worthiness. Before filing , make sure you’ve looked at all the debt relief options and considered what is right for you.
If you ask friends if you should file for bankruptcy, their likely response will be “Only as a last resort!” The reality is more complicated than that – bankruptcy may be your best option to reach financial stability. Or the consequences, including the hit to your credit for years to come, may not be worth any gains you would make. Everyone’s situation is different.
The decision to file for bankruptcy isn’t a simple matter of weighing pros and cons, but rather a more complicated issue of understanding your finances now, and what you would like your future to be.
Things to consider are:
- What kind of debt you have
- Does that debt qualify for bankruptcy
- Will filing allow you to keep your home and your car
- What financial steps you would like to take in the next 7-10 years when bankruptcy is sitting on your credit report like an albatross
- Is there a less severe debt relief option that will work better for you.
Let’s take a look.
What are the Main Causes of Bankruptcy?
Statistics about the causes of bankruptcy show that medical expenses, student loan debt, job loss and divorce are major reasons people file for bankruptcy. Many times, two or three of those causes can team up and light a torch to your financial plans.
While bankruptcy has declined rapidly since the all-time high of 2005, when more than 2 million people filed (followed by legislation that reformed bankruptcy law), skyrocketing student loan debt and medical costs are putting a lot of people in deep financial holes. Add this to reduced income from a divorce or job loss, and the problem is just compounded. While bankruptcy won’t discharge student loan debt, those struggling to pay those bills often rack up high credit card bills and other unsecured debt, which can be discharged by bankruptcy.
Many believe that people who file for bankruptcy are simply living beyond their means, but the main causes of bankruptcy are often more complicated – student loans necessary to get an education, a major illness – and the person is left without the means to pay their bills.
People in this situation often consider bankruptcy when:
- Creditors are suing for debt payment
- Their home is in danger of foreclosure
- The only way to pay for necessities is with a credit card
- They’re using one credit card to pay another
- They consider withdrawing money from a 401(k) account to pay bills
Things to Consider before Filing for Bankruptcy
Before filing for bankruptcy, there are debt relief options that you should consider. There are also some things you should avoid.
If you are struggling financially, you may have enough resources to right the ship, and not even realize it.
Talking to a counselor from a nonprofit credit counseling agency is a good first step, no matter what direction you end up going. A session with a nonprofit debt counselor is free of charge. They will review your finances and discuss the pros and cons of debt management plans, debt consolidation loans and debt settlement, as well as bankruptcy.
A credit counselor will help create a budget with you, but you can take that step on your own. A budget will help you get a realistic picture of what your finances really are. Creating a budget doesn’t have to be complicated. It’s simply a tool that helps you keep track of how much money you have coming in and how much your monthly bills and other expenses cost you a month. To make it work, review it frequently and find ways to cut expenses, if possible.
You may want to consider taking a second job or selling some assets to help pay down debt.
Also, take a hard look at your debt. Is there a way to negotiate it down, lowering interest or fees? Is it a temporary situation or a longer-term problem?
Also look ahead – if you have a big bill or big series of bills coming due, you may want to hold off until you decide if you’re going to file for bankruptcy.
There are also some things you shouldn’t do if you’re seriously considering filing for bankruptcy:
- Don’t pay creditors or debt collectors
- Don’t take on new debt
- Avoid unusual transactions (like transferring property to a family member or friend)
- Be honest about debt and income
- Don’t touch your retirement funds
- Use common sense
Do I Qualify for Bankruptcy?
There are two major types of bankruptcies for individuals: Chapter 7 and Chapter 13. Each one has specific qualifications. Neither of them has a minimum amount of debt required to file for bankruptcy.
Chapter 7 bankruptcy is designed for people who truly can’t afford to pay their bills, particularly unsecured debt. To qualify, you must earn less than the median income for a family your size in your state. If your income is too high to qualify, you can take the “means test,” in which a court trustee examines your income and reasonable expenses. If you have enough income to pay your bills, you fail the means test and can’t qualify for Chapter 7. If the trustee determines you don’t have enough income, you pass and can use the debt relief Chapter 7 bankruptcy provides.
If your income is too high for Chapter 7, the other option is Chapter 13 bankruptcy, which is known as the “wage earner’s bankruptcy” because it requires that you have a steady source of income and unsecured debts (credit cards, medical bills, personal loans, etc.) of less than $465,275 and secured debts (home, car, property, etc.) of less than $1,395,875 If you exceed those limits, Chapter 11 bankruptcy might be an option.
Debts that Qualify and Don’t Qualify for Bankruptcy
Not all debts qualify for bankruptcy.
Debts that qualify under both Chapter 7 and 13 include:
- Credit card debt
- Medical bills
- Personal loans
- Lawsuit judgments and obligations from leases or contracts
Chapter 13 will also wipe out debts from a divorce (except support payments) and debts for loans from a retirement plan. Technically, student loans can be discharged if you prove undue hardship, but it’s very, very difficult to prove.
Debts that don’t qualify for bankruptcy include:
- Child support
- Some taxes
- Debts to government agencies
- Secured debt, like car loans and mortgages
- Debts for personal injury caused by driving while intoxicated and any court fines or penalties.
There are some people who are considered “judgment proof” because everything they have is exempt under state law. Judgment-proof people may not have to file bankruptcy, because creditors can’t touch their assets if their source of income is from Social Security, pension plans, 401(k) retirement savings, disability benefits, veterans benefits, alimony or support payments.
What Are the Consequences of Bankruptcy?
Consider the consequences of bankruptcy when asking yourself if you should file:
Credit score: Your credit score most likely already has taken a beating because of nonpayment, but filing for bankruptcy will hurt your credit score further. It’s impossible to forecast exactly how far it will drop because too many factors are involved, but experts agree: the higher your score, the more you will fall. If you had a credit score above 700, a drop of somewhere around 200 points is likely. If you’re below 700, the drop could be more like 100-150 points. A Chapter 7 bankruptcy will remain on your credit report for 10 years and Chapter 13 will be there for seven years.
Co-signers: If you have a loan that was co-signed by someone, they agreed to pay if you can’t. In Chapter 7 bankruptcy, the co-signer will still be on the hook to pay. Creditors can go after them for payment, even if your bankruptcy case is discharged (successful). Chapter 13 is a different story. The protective stay that prevents creditors from pursing payments once you file for Chapter 13 extends to the co-signers. The stay remains in effect as long as you make regular payments on your Chapter 13 agreement.
Private life: Filing for bankruptcy means your name goes public. It’s not going to appear on a billboard downtown, but it is available to anyone with a PACER (Public Access to Court Electronic Records) account. The mandatory meeting with creditors occurs in a public forum and it appears on your credit report, for whomever has access to that. In some areas, it could appear in the legal notices of your local newspaper – though this no longer widespread.
Can You Keep Your Home After Filing Bankruptcy?
The good news about bankruptcy and your home is that you won’t lose it – as long as you can make the monthly mortgage payments.
Remember that the purpose of bankruptcy is to give you a chance for a fresh start and it’s a lot easier to start over if you’re not homeless. That’s why bankruptcy laws make homes exempt from creditors’ claims.
If living in a house you can’t afford is part (or all) of the reason you’re filing bankruptcy, then yes, you could (and probably will) lose your home.
In Chapter 7, if you fall behind on payments, you can seek protection for your home by filing Chapter 13 to allow you time to catch up. Or, you may have to throw in the towel and let the bank foreclose.
In Chapter 13, it’s far more complicated, but you essentially return to the default status you were in before declaring bankruptcy. That means creditors who have claims against you can go after you for payment.
Can You Keep Your Car After Filing Bankruptcy?
The bankruptcy system is set up to allow people who file to keep their car. An auto loan is a secured debt – the car is the “security” that you will continue to pay. If you don’t, the lender repossess your car. Bankruptcy discharges unsecured debt.
If you are still making payments on an auto loan, Chapter 7 allows you to “reaffirm” the loan or buy the car outright. Chapter 13 allows people to continue to pay their car loan under a structured plan, but the payments must be made on time. Being up to date on your auto loan payments when you file for bankruptcy makes it more likely you’ll be able to keep it.
If you are no longer paying on your car, it’s an asset and must be listed with your assets, but you will likely be able to keep it.
Are There Any Benefits to Bankruptcy?
Bankruptcy can lead to financial stability.
If you can’t find a way to get out of debt in the next five years – and have diligently researched solutions – then bankruptcy may benefit you.
Some of the benefits are:
- A second chance to stabilize finances
- A stop on calls and mail from debt collectors
- Improved long-term financial stability.
- An automatic stay, which halts foreclosures and other legal judgments on money you owe
Everyone’s situation is different, so weigh the pros and cons of bankruptcy as they relate to your financial situation and what you want in the future. Whatever position you’re in, don’t panic. There is a solution. Remember, you can’t go to jail just because you owe someone money, so find a way to fix the problem.
The answer to the question, “Should I file for bankruptcy?” depends on how the qualifications and consequences fit into your financial situation. Whether most of your debt is unsecured or secured, whether the consequences will do financial damage that will hurt your plans for the future, whether you can see another way to resolve your debt challenges – it’s all up to you.
If bankruptcy is the only choice that makes sense after researching all other options, then the answer is “yes.”
The next steps, which will help guide you through the filing and court process are:
Hire a bankruptcy attorney. The bankruptcy process is complicated, with many steps, deadlines and forms to fill out. People who tackle it by themselves often aren’t successful in getting their debt discharged. A bankruptcy attorney generally costs around $1,500 for Chapter 7 and $3,500 for Chapter 13.
Pre-bankruptcy credit counseling. This is required for anyone filing bankruptcy. Credit counseling can also help you stay on track after your debt is discharged in Chapter 7 bankruptcy, or you’re in a 3-5 year Chapter 13 restructuring plan.
Whether you decide bankruptcy is right for you or not, nonprofit credit counseling can help you figure out the best way to attack your debt and rebuild your credit.
About The Author
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].
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