Should I file for bankruptcy?

Often when asking someone whether you should file for bankruptcy, the refrain is almost always: “Only as a last resort!”

Debt consolidation companies have made fortunes convincing borrowers that this is sound advice, and yet, more than 70% of people who sign up for debt consolidation programs still can’t find a way out of their financial troubles.

Be careful as you weigh your options. Bankruptcy does take a toll and it’s not just financial. There has always been a societal stigma attached to it and, for some reason, American consumers have viewed bankruptcy as a financial scar that marks you as a failure the rest of your life.

The Effects of Bankruptcy

If we have learned anything from our history it is that countless financial successes have emerged from the seeming ruin of bankruptcy - business men, entrepreneurs, even Presidents have all filed for bankruptcy, some even multiple times, and still managed to succeed in their respective careers.

The effects of bankruptcy is more like a financial scab, something that looks nasty for a while, but with care and attention, eventually clears up and fades away. It’s a chance to start all over again. That’s the reason bankruptcy laws were written, to give people a second chance, not to punish them.

But first, weigh both sides of the issue before deciding.

Reasons to Consider Filing for Bankruptcy

Surveys agree there are numerous leading causes for filing bankruptcy, but job loss and excessive medical debts are among the two biggest reasons for considering bankruptcy. Many times, the two team up and light a torch to a family’s financial plans.

Health problems can make it difficult or even impossible to do your job. The result is you either quit or are let go by the company. That is a toxic combination because you lose your source of income at precisely the same time expenses go up.

There are other reasons that could cause you to consider bankruptcy. You might be headed down that road if:

  • You are getting a divorce
  • Creditors are suing you for payment of debts
  • The home you own is under water and in danger of foreclosure
  • The only way you can pay for things is using a credit card
  • You use one credit card to pay off another
  • You are considering withdrawing money from a 401(k) account to pay bills

Things to Consider before Filing for Bankruptcy

There are other debt-relief solutions than bankruptcy available for people who are struggling financially, but have enough resources to right the ship.

Calling a counselor from a nonprofit credit counseling agency is a good first step. They offer a free counseling service that looks at your finances and discusses the pros and cons of a debt management program, a debt consolidation loan or even debt settlement, any of which might help guide you back to safe ground.

Another step in the right direction would be to get serious about creating and living within a budget. You could supplement your current income with things like taking a second job or trying to sell some assets to pay bills.

Other things to consider before making a final decision: Did I try to negotiate the debt down to manageable numbers? Is my current status permanent or is the situation expected to improve soon?

A final consideration: Do I have a big bill or series of big bills coming due soon? You might want to hold off on paying that until you decide whether or not to file bankruptcy since those bills could be dismissed through bankruptcy.

Here are some other questions you need to answer before making a decision on whether you want to file bankruptcy.

Do I Qualify for Bankruptcy?

The two types of bankruptcy for individuals: Chapter 7 and Chapter 13 , each with its own qualification requirements.

Chapter 7 bankruptcy is designed for people who truly can’t afford to pay their bills.  To qualify, you must earn less than the median income for a family your size in your state.  The median income is part of a group of statistics maintained by the Department of Justice for use in bankruptcy proceedings.

If your income exceeds the median income in your state, you could try to pass a “means test” in which a court trustee examines your income and “reasonable” expenses to determine whether you could pay these bills, or really do need the relief Chapter 7 bankruptcy provides.  Failing the means test will require you to consider filing under a Chapter 13.

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 $394,725 and secured debts (home, car, property, etc.) of less than $1,184,200.  In a Cahpter 13, you will be required to repay some, or maybe all of your debts, depending on the amount of verifiable disposable income.  The repayments are made over a period of either 36 or 60 months, and are subject to confirmation of the bankruptcy judge.

Do My Debts Qualify for Bankruptcy?

Not all debts qualify for bankruptcy. Debts that can’t be wiped out are child support, alimony, some types of taxes, debts to government agencies, debts for personal injury caused by driving while intoxicated and any court fines or penalties.

Debts that can be wiped out in Chapter 7 bankruptcy include credit card debt, medical bills, personal loans, lawsuit judgments and obligations from leases or contracts. Chapter 13 bankruptcy wipes out those debts, plus debts from a divorce (except support payments), debts for loans from a retirement plan. Technically, student loans can be discharged if you prove undue hardship, however, this is often a difficult task.

There are some people who are considered “judgement proof” because everything they have is exempt under state law. People that are judgment proof may not need 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.

Impact of Bankruptcy

If you are thinking about whether to file for bankruptcy, consider the consequences as well.

Here are just a few of the areas bankruptcy can touch:

  • Credit score. Most likely, your credit score 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 over 700, it could drop 100-200 points. If you’re under 700, the drop could be more like 75-150 points. What is for sure is that a Chapter 7 bankruptcy will remain on your credit report for 10 years and Chapter 13 will be there for seven years.

  • Co-signers. These are people who sign their name to a loan, saying they will pay if the person receiving the loan does not. In Chapter 7 bankruptcy, the co-signer is on the hook. Creditors can go after him/her for payments, 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. That 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 is an outdated practice and no longer widespread.

Bankruptcy Impact on Home

The good news about bankruptcy and your home is that you won’t lose it – as long as you can make 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 partially exempt from creditors’ claims.  Depending on your county, the amount of equity in your home may be exempt from creditors in bankruptcy.

But only if you can make the payments.

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 making payments, you could 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 on you.

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.

Will Bankruptcy Benefit You?

With so many factors involved in the decision-making process, a “Yes” or “No” answer isn’t possible, but here is a good guideline to use in making a final decision.

If you can’t find a way to get out of debt in the next five years – and have diligently researched solutions – then yes, bankruptcy can benefit you.

But weigh the pros and cons and remember one other thing: You can’t go to jail just because you owe someone money.

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