When Should You Consider Filing For Bankruptcy?
You’re in financial distress and you’re not sure what to do. You’re past due on your mortgage, you’ve racked up considerable credit card debt and you’re well on your way to missing your next car payment.
If you’re ready to take control of your finances but aren’t able to pay off all your debts, bankruptcy might be the right option for you. It can allow you to have a fresh financial start bolstered by better money habits than you had before.
5 signs you should consider declaring bankruptcy
Knowing whether you’d be a good candidate to file for bankruptcy can be tricky. It’s a major step, and one that shouldn’t be taken lightly.
But, for some people, declaring bankruptcy is the only way to get out of serious debt.
The most important thing is to identify what your goal is when filing for bankruptcy, said LynAlise Tannery, a bankruptcy attorney with Bonial & Associates P.C. based in Dallas.
“Know what your goal is,” she said. “Are you trying to file for bankruptcy because you are past due on your house and you don’t want to get foreclosed? Or maybe you’re current on your house and car, but you had surgery and your insurance didn’t cover it, and you have all of these medical bills you can’t pay. Try to see what your end goal is when you want to file for bankruptcy, [and] go talk to a debtor bankruptcy attorney about that.”
Here are some signs that bankruptcy might be the right solution for you.
You have bills in collections that you cannot pay off.
If a medical procedure put you in significant debt and you’ve already exhausted all your other options for paying it back, you might want to consider filing for bankruptcy.
Or if you’ve racked up significant credit card debt and other methods for paying it back (such as a debt consolidation loan or negotiation) have failed, bankruptcy might be right for you.
You risk losing your home.
If you’re past due on your mortgage and are at risk of foreclosure, you might want to consider filing for Chapter 13 bankruptcy, which can allow you to keep some of your assets. You can work with your lender to create a repayment plan that will allow you to stay in your home.
You want to protect your retirement savings.
If you’re in significant debt but don’t want to dip into your retirement savings such as your 401(k), filing for bankruptcy can allow you to get a fresh start while still keeping those assets. It depends on your situation, but retirement savings accounts are protected during bankruptcy in most cases.
You had a serious life event such as an illness, loss of a job or death in the family.
If a sudden, unexpected and detrimental life event has left you in financial distress, filing for bankruptcy might be the only way to regain your footing. A nonprofit credit counselor or bankruptcy attorney can help you figure out whether your financial situation merits bankruptcy.
You don’t expect any other solution could get you back on your feet.
If you’re swimming in mountains of debt and have been for years, bankruptcy might be your only solution. If you’re willing to do the work necessary to learn about financial discipline and budgeting, filing for bankruptcy can allow you to have a fresh start.
Types of bankruptcy
Bankruptcy happens when someone owes money to a creditor (or various creditors) and cannot pay it back.
If you are in debt significantly and have already tried everything else to get yourself on the right track financially, declaring bankruptcy might be the best option for you. But that doesn’t mean it should be taken lightly.
“The first and most important thing for people to realize is that filing for bankruptcy is a very serious and also very traumatic step,” said Anthony Sabino, a professor of law at St. John’s University and a bankruptcy attorney with Sabino & Sabino in Mineola, N.Y. “Because, in essence, you’re admitting financial defeat. You are giving up control of your assets. It’s going to be a difficult process. It’s going to be a painful process. And the bottom line is that it’s going to hurt.”
Although there are some slight variations at the state level about exemptions that can be claimed, bankruptcy law is federal, so the process is fairly standardized, said Tannery, who also teaches bankruptcy law for the paralegal studies program at Collin College in Frisco, Texas.
There are two forms of consumer bankruptcy: Chapter 7 and Chapter 13 (Chapter 11 is for businesses). The main difference between the two is that one involves complete liquidation of someone’s assets, while the other allows a person to keep some (or all) of their assets.
“In Chapter 7, you lose everything — you’re only left with the shirt on your back — but you have all of your debts discharged,” Sabino said. “And it operates quite a bit faster. In Chapter 13, the benefit of taking it if you qualify … [is that] you get to keep your stuff while you work down your debt and then eventually emerge debt-free.”
Below, you’ll find additional details on each form of consumer bankruptcy.
Filing for Chapter 7 bankruptcy means that all your nonexempt assets will be liquidated to pay back your creditors. Typically, Chapter 7 bankruptcy lasts anywhere from three to six months, if not longer. This form of bankruptcy is referred to as fresh-start bankruptcy.
“In Chapter 7, you lose everything … your home, your car, your bank accounts, your household possessions,” Sabino said. “You are left with just a few ordinary household goods and the clothes on your back. In return, when the creditors get paid, all of your debts are wiped out.”
But not everyone can file for Chapter 7 bankruptcy. “In order to be eligible to file a Chapter 7 bankruptcy, you have to be below a certain income level,” Tannery said. This is called a means test, and the salary threshold depends on the cost of living in your state.
Chapter 7 bankruptcy is more common than Chapter 13. “If you take the total number of bankruptcies that are filed in the United States every year, the largest percentage of those are Chapter 7 cases,” Tannery said.
Filing for Chapter 13 bankruptcy involves proposing a repayment plan that covers how you will repay everything that’s past due. This form of bankruptcy is known as repayment bankruptcy. Repayment plans typically last anywhere from 36 to 60 months, and when you finish paying your creditors, you have a clean slate.
The major difference between Chapter 7 and Chapter 13 is that, with Chapter 13, you get to keep most of your assets.
“In Chapter 7, you file and you lose everything,” Sabino said. “In Chapter 13, you get to keep your stuff while you conform to this three- to five-year budget plan. But if you fall out of the plan, then you’re going to be in Chapter 7 and lose everything anyway.”
Sabino said two-thirds of Chapter 13 bankruptcy cases fail. But when it works, it’s typically a better form of bankruptcy to file.
“If people qualify for Chapter 13 — and the law basically pushes you into it in any event to see if you can do it — the benefit is that if you can stick with the budget, the stuff you have you [get to] keep,” he said. “But, again, it’s really an uphill battle to stay within that budget.”
Which type of bankruptcy is best for you?
|Which type is best for me?|
|Type of bankruptcy filing||Best if …||Avoid if …|
|Chapter 7||You are in serious financial distress and are looking for a fresh start.
You don’t have the means to pay back your debts within 36 to 60 months.
|You have a decent salary, are capable of repaying your debts over a 36- to 60-month period and you have assets, such as a home or a car, that you would like to keep.|
|Chapter 13||You have a salary high enough that it will allow you to steadily pay back your debts.
You have assets, such as a home or car, that you desperately want to retain.
|Your financial situation is in bad shape, and you don’t have many assets worth keeping.
You don’t expect to be able to stick to a repayment plan.
3 risks to watch out for if you declare bankruptcy
You cannot discharge your student loan debt.
Unfortunately, it is extremely unlikely that you will be able to discharge student loan debt by filing for bankruptcy. It can be done, but it is rare. “In order to be able to get your student loans discharged, you have to prove hardship,” Tannery said. “And it’s a pretty broad and vague term.”
For example, the one time Tannery recalls someone getting her student loans discharged involved a woman with a bachelor’s and master’s degree who worked as an educator and suffered an accident that left her unable to ever work again. “The court ruled that that was the hardship that would allow her to discharge those student loans,” Tannery said.
Your credit will take a big (and long-lasting) hit.
When you file for bankruptcy, your credit will take a hit of anywhere from 100 to 200 points. Aside from the big dip to your score, the bankruptcy will stay on your credit report for at least 10 years (Chapter 7) or seven years (Chapter 13).
You will struggle to secure credit in the future.
Bankruptcy is public record and stays on your credit report for a long time (Chapter 7 is ten years and Chapter 13 is seven years from filing date) so you will likely struggle to secure credit of any form in the future. “Banks and other lenders are going to be reluctant to do business with you, and that’s just the reality of it,” Sabino said.
With time, it’s possible to practice good financial habits and rebuild your credit report and score. But it’s likely that filing for bankruptcy will have a lasting effect on your financial life. “The pain of you filing for bankruptcy never truly goes away,” Sabino said. “The more distance you place between yourself and the time your bankruptcy case ended, the better.”
Alternatives to bankruptcy
Before filing for bankruptcy, consider some of the following alternatives:
Negotiate with your lenders.
Whatever form of debt you hold, it’s possible to negotiate with your creditors. You might be able to get a one-month extension on your car payment, have some of your interest-only credit card debt forgiven or obtain a mortgage modification.
“I would always advise trying to negotiate with your creditors directly first before just filing for bankruptcy,” Tannery said. “Because you may be able to gain the result you need without having to use the bankruptcy court.”
Take out a debt consolidation loan.
If your debt is in multiple buckets and you’re struggling to stay organized, you can take out a debt consolidation loan. For example, you could take out one low-interest personal loan and use the money to pay off your higher-interest debts, reducing your overall interest costs.
“It’s not going to reduce the total debt, but what it can do is give you one monthly payment,” Tannery said. “People struggle with knowing what they owe and when they have to pay it, especially when they’ve got multiple payments coming through every month.”
Meet with a nonprofit credit counselor.
Nonprofit credit counselors can help you learn about healthy financial habits and also negotiate with your creditors if you’re struggling to do so on your own.
“We find a lot of people who file for bankruptcy don’t understand basic budgeting, and they don’t understand how much something is actually going to cost them in the long run when they put something on a credit card or buy something with a really high interest rate,” Tannery said.
“These credit counseling services can help you negotiate with your creditors and arm you with the right tools so that, going forward, [you know how] to avoid getting in that spot again.”
Find a way to borrow money from family or friends.
If your debt is due to a sudden life event and you expect to be on solid ground soon, consider borrowing money from family or friends. Because of the emotional component of this strategy, you should only consider it if you’re certain you will have the means to pay back the loan as agreed.
If your debt is primarily student loan-related, consider an income-driven repayment plan.
Income-driven repayment plans involve paying back your federal student loan debt at a rate that is consistent with your income. These plans can last up to 25 years, and lowering your monthly federal student loan payment could help you get through a particular financial hardship you might be experiencing.
How to file for bankruptcy
Sabino and Tannery both warn strongly against trying to file for bankruptcy on your own.
If you think filing for bankruptcy is right for you, get in touch with a bankruptcy attorney who represents debtors. Tannery recommends bringing all the financial information and paperwork you can gather with you. Make a list of exactly what you owe.
If you and your attorney decide filing for bankruptcy is right for you, the first step will be filing a petition with the clerk in whichever jurisdiction you live (there are 94 bankruptcy jurisdictions in the U.S.). The petition involves basic demographic information such as your name, address and contact information, Tannery said. After filing the petition, you have 14 days to file all your required schedules.
“Your schedules essentially have all of the big details about your financial life,” Tannery said. “They show all of your assets, all of your liabilities, all of your secured creditors and unsecured creditors.”
One schedule includes your income and all your expenses broken down. This includes your gross monthly pay, how much goes to health insurance, how much goes to your 401(k), how much goes toward household expenses and other items. “Your schedules are what show the court and the bankruptcy trustees and your creditors exactly what’s going on in your financial world,” Tannery said.
Sabino said the most important thing to remember is that filing for bankruptcy isn’t a cure-all. After filing, you will need to learn about and maintain good financial discipline.
“[After filing], you have to be really careful and rebuild your life,” he said. “And most especially, get back into good financial standing by staying out of debt. … You really have to be on the straight and narrow once you come out of bankruptcy.”
And remember: Although it is stressful and should not be taken lightly, bankruptcy shouldn’t cause you shame or guilt. It is common. In 2017, over 742,000 individuals in the U.S. filed for bankruptcy. If it’s the only thing that will get you out of debt and on the right path, then it could be the right decision for you.