When you’re drowning in debt, bankruptcy may seem like the only way to find relief. You will have to hire an attorney, deal with your credit score taking a hit, and accept that it may be difficult to qualify for credit and loan products for some time. But you’ll be free of the stress caused by not knowing how to get your debt balances under control or if you should deprive yourself of basic needs to appease creditors.
However, there are some instances where bankruptcy isn’t the best choice. Perhaps there are more feasible alternatives that won’t tank your credit score and have other lingering effects for years to come?
Regardless of which direction you take, be mindful that there are three types of bankruptcy filings and each has a different set of qualification criteria. Read on to learn more, along with additional guidance on how bankruptcy impacts your credit rating, how to determine if you should file, and other options that may be worth considering.
Types of Bankruptcy
Chapter 7 Bankruptcy- Discharge
Chapter 7 bankruptcy, which is also known as liquidation, will discharge all your debts and give you a clean slate. This means you’ll no longer be obligated to repay but you owe. But here’s the catch: you will have to relinquish your assets so they can be sold. And any proceeds generated will be distributed to creditors to cover a fraction of the outstanding debt.
Debts are dischargeable under Chapter 7 include:
- Credit card and personal loan debt
- Delinquent medical bills
- Outstanding rent obligations and utility bills
- Government benefit overpayments
- Secured debt from a surrendered property
- Select tax debts
To learn more about chapter 7 bankruptcy, refer to this comprehensive overview.
Chapter 13 Bankruptcy- Reorganization
If your income is too high for chapter 7, you may be able to file for chapter 13 bankruptcy. But instead of having your debts discharged, you’ll be placed on a repayment plan that spans from three to five years. And upon successful completion of the repayment plan, whatever outstanding balances that remain will be discharged.
While you’ll have to repay a portion of what you owe, you’ll have the benefit of retaining your assets. The following debts are eligible for a repayment plan and subsequent cancellation of what remains under chapter 13 bankruptcy:
- Credit card and personal loan debt
- Delinquent medical bills
- HOA and condo fees accrued after the date of filing
- Outstanding rent obligations and utility bills
- Government benefit overpayments
- Debt related to non-dischargeable tax debt
- Property damage debts caused by willful or malicious intent
- Property settlement agreement debts stemming from legal separation or divorce
- Qualifying monetary judgments
- Qualifying government fines that aren’t related to penalties resulting from criminal activity
- Retirement account loans
- Secured debt from a surrendered property
- Select tax debts
You can find additional information about chapter 13 bankruptcy right over here.
Chapter 11 Bankruptcy
Don’t quite qualify for chapter 13 bankruptcy because of your earnings? Chapter 11 may be an option for you, although it’s commonly used by companies, and you may not have to give up some of your prized possessions.
The key differences between chapter 11 and chapter are as follows:
- It’s’ a bit more costly than chapter 13 bankruptcy.
- The repayment period will span 5 years instead of 3 years.
- You’ll have to pay the total outstanding balance on “priority” debts.
- You’re allowed to restructure your debts so you can get current on your delinquent accounts. and refrain from being forced to cease operations in your business.
There’s additional guidance on chapter 11 bankruptcy in this guide.
How Bankruptcy Impacts You Over Time
Although bankruptcy can be used to alleviate financial strain in the short-term, the long-lasting effects could be dreadful. The first major issue is that once the bankruptcy record hits your credit report, your FICO score could drop by over 150 points. And if your score was already in the trenches due to late payments, charge-offs and collection accounts, this only makes matters worse.
A Chapter 7 bankruptcy will linger on your credit report for a whopping 10 years, while Chapter 13 will only be reported for 7 years. But there is a light at the end of the tunnel since you won’t have to wait until the reporting timeline lapses to start being eligible for debt products again. As the impact diminishes and your credit score starts to improve, lenders and creditors may give you another shot. However, interest rates will probably be steep.
You should also consider the impact a bankruptcy could have on other areas of your life. It may be more difficult to secure affordable auto insurance premiums since some providers review credit reports. And when you apply for a job, the employer may screen your credit and turn you away if the position is in the financial services industry.
Planning to apply for an apartment soon? Bankruptcy could also mean an exorbitant deposit requirement from the landlord and utility providers to minimize their risk of loss if you’re application isn’t denied. And if you’re thinking a mortgage will allow you to avoid the red tape, think again. Mortgage lenders may require you to wait up to five years, regardless of your credit score, before they’ll consider you for a new home loan.
For these reasons, you have to ask yourself if filing bankruptcy is the best possible way to remedy your financial issues. You may find that there are other ways to find relief that won’t be nearly as damaging to your credit and overall financial health.
Should You File Bankruptcy?
There’s no right or wrong answer here. It depends on your financial situation and if there are better alternatives out there that can help you sort out the mess.
The Case for Bankruptcy
Filing for bankruptcy has its benefits. For starters, you could minimize damage to your credit score since creditors won’t continue to update the status of collection accounts and charge-offs each month that are on your credit report. As mentioned earlier, the initial hit from the bankruptcy will tank your score, but you’ll have a chance to rebound from the damage if you take the proper steps to manage your credit responsibly moving forward.
Also, the phone calls and letters from debt collectors will stop right away. And the chance of having a judgment against you will go away as well since they’ll be prohibited from moving forward with collection proceedings.
Most importantly, you’ll alleviate the stress associated with financial worry. You won’t have to spend your days and nights trying to figure out how you’ll knock down your mountain of debt or deciding between paying a bill or feeding your family.
Below are some questions to ponder if you’re seriously considering bankruptcy?
- Are credit cards, payday loans, or other sources of fast cash used as a means of survival?
- Can you afford to make the minimum payments on your credit cards and loans?
- Have you been hit with penalty APRs due to late payments on your credit cards?
- Is your credit score being dinged each month with late payments or new collection accounts?
- Are you dealing with wage garnishment as a result of a judgment?
- Have you exhausted all your reserves and cash sources, including retirement, to pay off debt but the load is still too heavy?
- Are you working several jobs to earn extra income but it’s still not enough to keep up with bills and monthly debt obligations?
- Are debt collectors flooding you with calls and letters?
Your answers to these questions will give you additional insight into the severity of your financial situation and if it calls for a bankruptcy filing or if another approach is best.
How to File Bankruptcy
Step 1: Solicit the assistance of a licensed credit counselor.
A licensed credit counselor will sit down with you to review your finances and weigh in on your best course of action. The final decision is yours to make, but it’s possible that all you need a more structured financial plan to control your spending and pay down debt. But if there’s very little hope for recovery, they’ll analyze your situation to determine if you qualify for bankruptcy or if you should seek other forms of debt relief. More on that shortly.
Step 2: Hire a bankruptcy attorney.
You have the option to file bankruptcy on your own and represent yourself in court, but it’s much wiser to hire a bankruptcy attorney to handle all the legwork for you. Hiring a bankruptcy attorney means you’ll have to spend money that may seem a bit difficult to spare.
However, it’ll be well worth the investment in the end since you run the risk of a bankruptcy dismissal if you fail to conduct the proper research to determine if you qualify. The courts will also want to dig into your finances by analyzing your income, expenses, and any assets you have at your disposal, and your attorney can help you gather all the documents you’ll need.
Before hiring a bankruptcy attorney, shop around to see what those with affordable rates have to offer. Also, ask around for recommendations and read independent reviews and testimonials from prior clients.
Viable Bankruptcy Alternatives
Still on the fence about filing bankruptcy because you don’t quite know if it’s the right approach for you? Some viable alternatives to consider:
- Credit counseling- you may just need a realistic budget and debt payoff plan to get back on track
- Debt consolidation– makes monthly payments more affordable by merging all your debts under one umbrella with a set interest rate that is usually lower than what you were paying before
- Debt settlement- allows you to pay your creditors a fraction of what you owe to satisfy your debt obligations (but there are negative tax and credit implications that you should consider)
- Negotiate with creditors- they may be willing to enroll you in a financial hardship plan that minimizes or freezes the accrual of interest and grants you a lower monthly payment
- Sell your assets- helps you raise funds to allocate towards delinquent accounts so you can get current and back on track
And as a last resort, you can wait it out if you can’t afford to repay your debts. There’s a possibility that the creditors and collection agencies will get fed up and sue to get a judgment against you. If you have minimal income and assets at your disposal, there won’t be anything left to take. But you should consult with a bankruptcy attorney for additional guidance.
The Bottom Line
It’s not the end of the world if you have to file bankruptcy. However, you want to exhaust all your options beforehand. And if you decide to move forward with filing bankruptcy, be sure to reflect on your past actions to pinpoint the source of your financial distress. Ultimately, you want to prevent history from repeating itself and have financial freedom and peace of mind once the bankruptcy is over and you have a clean slate.
