Bankruptcy is the nuclear option of debt relief: it may solve some of your debt problems, but it causes a host of others. So how do you decide whether you should file bankruptcy or continue trying to pay down your debt?
If you’re considering filing for bankruptcy, here’s what you need to know to determine if the potential benefits will outweigh the certain negatives:
Chapter 7 is the most common type of personal bankruptcy filed, and it requires a debtor to surrender all of their non-exempt property to a trustee for liquidation. (Exempt property generally includes things like household goods, clothing, etc.) The money generated from this liquidation is given to the creditors in exchange for discharging the rest of the debt. However, any creditors for secured assets, such as cars, have the right to repossess the collateral even if the debt has been discharged.
Individuals filing for this type of bankruptcy will have to prove that they’re eligible for this type of debt relief through a “means test,” which looks at your income and debt. The specifics for the means test vary from state to state, so it’s worth it to consult a bankruptcy attorney to help you. Any individual considered ineligible for Chapter 7 bankruptcy may have to switch to Chapter 13 filing.
This type of bankruptcy is only available to a debtor who has regular income. Chapter 13 allows the debtor to keep all of their property and assets, but sets out a repayment plan over three to five years to repay creditors. At the end of the repayment period, the remainder of the debt is discharged.
Benefits of Filing
Filing for bankruptcy can provide an individual or a family a great deal of relief — and not just financially. Sometimes, people will file for bankruptcy just to get the debt collectors off their back, giving the individuals (and their family) space to rebuild their lives after months of debt collector hounding.
If the insurmountable debt came about because of a single incident or several instances of bad luck, such as a medical bill, divorce, job loss, etc, bankruptcy can offer the breathing room necessary to get back on your feet.
On the other hand, bankruptcy doesn’t erase or change bad spending habits. So unless you have a plan for change, you may be facing many negative consequences on top of poor money habits that can land you back in the same situation.
The biggest repercussion that bankruptcy has on an individual is the credit hit. Not only does your credit score take a major dip after bankruptcy, but the bankruptcy itself stays on your credit report for 10 years. Considering the fact that many employers now do credit checks on their potential employees, along with criminal background checks, there’s the possibility that a bankruptcy declared in 2012 could cost you a job in 2022.
In addition, any plans you have for your life that would require a loan — buying a house, starting a business, or even buying a car — will have to be put on hold until you’ve shown yourself credit-worthy again.
Even if the numbers make sense for you to declare bankruptcy, the emotional aspect of filing is something you shouldn’t ignore. There’s definitely a stigma still associated with bankruptcy, despite it becoming more and more common since the economic downturn. How will you feel about yourself, your finances, and your family if you have to declare bankruptcy?
If you need to use this tool to free yourself from an overwhelming debt load, you’ll also need to take the time to work on your own emotional health. The natural feelings of embarrassment and shame in the wake of declaring bankruptcy can often send individuals looking for quick emotional fixes, like shopping or gambling, which can just restart the cycle all over again. Be prepared to feel more than just relief when your debt is discharged.
The Bottom Line
Whether you owe $15,000 or $150,000, debt can feel like it’s crushing you if you can’t repay it. Bankruptcy can offer some relief, but at a price. If you decide to file, make sure you consult with a reputable bankruptcy lawyer, understand all of your options ahead of time, and go into filing with your eyes wide open.
Have you ever declared bankruptcy, or thought about doing so?