If debt is taking over your life, it can be difficult to see a way out. Maybe you’ve been trying to pay off your debt but aren’t making enough progress. Or maybe you’re just in over your head and need a way out. You might be considering bankruptcy.
Filing for bankruptcy can be an overwhelming choice when you’re drowning in debt. It may sound like a good idea to start over, but bankruptcy comes with big repercussions. If you’re thinking about declaring bankruptcy, weigh the pros and cons first.
Bankruptcy 101: Chapter 7 vs. Chapter 13
There are two common kinds of bankruptcy filings you can choose from: Chapter 7 and Chapter 13.
In Chapter 7 bankruptcy, your property is sold off to pay your outstanding debts. Most of what you own — with some exceptions — can be seized to pay off your debt.
Chapter 7 is sometimes referred to as “liquidation bankruptcy” because your property is liquidated to pay back the money you owe. But Chapter 7 also requires applicants to prove they have a very low income. If you don’t meet the eligibility for Chapter 7, you may not be able to file it.
Those that don’t qualify for Chapter 7 may choose to file Chapter 13 bankruptcy instead. This process doesn’t liquidate your property. Rather, this filing sets up a court-ordered repayment plan, usually lasting between three and five years. After completing the repayment plan, any remaining debts may be eligible for discharge.
5 possible benefits of bankruptcy
Bankruptcy is a negative word, but there’s some good that could come out of it. When given the chance at a new beginning, you may feel more prepared to handle your money better than you did before.
1. You could consolidate your debt (or have it discharged)
Keeping up with debt payments is hard when you can’t afford them at all. Bankruptcy allows your debt to be consolidated into manageable payments. Sometimes your responsibility for some debt can be wiped away. The filing you select will determine this.
2. You may get to keep your property
There are some personal exemptions when you file for bankruptcy, so you could keep things like your home, car, or retirement accounts in either Chapter 7 and Chapter 13 filings. Exact exemptions depend on the state you live in and the value of your assets, so consult a professional if you’re not sure what property may be at risk.
While some assets may be protected in certain circumstances, it’s not guaranteed you’ll keep the rest of your property — particularly under a Chapter 7 filing. A Chapter 13 filing is usually a safer bankruptcy option if you’re a homeowner or have other major assets.
3. Chapter 7 bankruptcy can be completed quickly
The timeline for your bankruptcy completion depends on which option you file under. A Chapter 7 bankruptcy can often be completed in fewer than six months. That means you’ll be able to restart your credit journey relatively quickly. Compare this to a Chapter 13 filing, which can take years to complete the mandatory repayment plan.
4. Filing bankruptcy should put a stop to collection attempts from your creditors
When you file for bankruptcy, creditors must stop contacting you to collect a debt. In fact, creditors aren’t allowed to contact you throughout the bankruptcy process — from when you file to when that debt is discharged. However, not all debt is discharged during bankruptcy (more on that below), so if you’re getting hounded for an outstanding debt, check to see if you’re still responsible for it.
5. You can start with a clean slate
When you’re drowning in debt and can’t see a way out, bankruptcy gives you the opportunity to start over with a clean slate. Although there are some instances where debt isn’t gone after bankruptcy, you could have most of it wiped away or reduced and paid off through a repayment plan. A fresh beginning can help you restart your financial journey on the right path.
8 drawbacks of bankruptcy
Bankruptcy has the potential to help you in a dire financial situation, but it can also have devastating consequences for your future. Bankruptcy should be a last resort when you’ve run through all your other options to take care of debt. If you’re considering it, make sure you know the possible blows you’ll face.
1. Your credit will tank
If you’re months (or years) late in paying outstanding debt, your credit score is probably pretty low already, but a bankruptcy filing can still cause additional harm to your score. The more accounts listed in your bankruptcy filing, the bigger the impact on your FICO credit score. Along with that, a bankruptcy filing can stay on your credit report for seven to 10 years, depending on which chapter you file under.
2. It could be harder to borrow in the future
Having a bankruptcy mark on your credit report is like having a black cloud over your head for as long as a decade. Lenders see bankruptcy marks as a big red flag and will be hesitant to work with you. It could stop you from getting a home, car, or even a credit card in the future.
3. Not all types of debt are eligible for bankruptcy
A big misconception with bankruptcy is that if you declare it, you’re no longer responsible for paying any current debt. However, not all debt is eligible to include in bankruptcy filings. For example, student loans and mortgages are usually still your responsibility after you file. Even if you declare bankruptcy, you still may have to face outstanding debt. Depending on the debt you struggle most with, bankruptcy may not be worth it.
4. Your property might be repossessed
When you declare Chapter 7 bankruptcy, your assets are liquidated to pay off your outstanding debt. That means almost anything you own has the opportunity to get repossessed to make sure your debt gets paid. While Chapter 13 temporarily safeguards your possessions because you’re under a repayment plan, you may still face repossession if you don’t stick to the court’s orders.
5. It can be hard to qualify for
If you’re declaring Chapter 7 bankruptcy, you’ll need to prove you can’t afford to repay your debt through a means test. This test is to ensure your income is low enough to declare bankruptcy. If it isn’t, your disposable income will be evaluated to see that after your important expenses are paid (like housing and child support), you don’t have anything left over to pay for your debt. Not everyone qualifies for this option.
6. It could take years to complete the process
If you successfully declare Chapter 13 bankruptcy, you could see years of paying a court-ordered repayment plan. Repayments under a Chapter 13 filing typically take anywhere from three to five years to complete.
7. Your cosigners could be on the hook
While cosigners can help you secure a low-interest loan or a credit card, they’re taking on an enormous responsibility. When you don’t pay back your loan that someone else has cosigned for, it crushes your credit score and theirs. Along with that, they’re still responsible for paying unsecured debt that has their name on it, even when you file for bankruptcy.
8. Bankruptcy isn’t free
From filing for bankruptcy to attorney fees, you could be on the hook for hundreds or even thousands of dollars. Filing costs more than $300 for both chapters (though filing fees may be waived in some instances), and if you hire an attorney, you could pay thousands of dollars in legal bills. And remember, if you file for Chapter 13, you’ll have a repayment plan set up, so you’re still paying for your debt long after you declare.
Should you file for bankruptcy?
If you’re considering bankruptcy, you have a lot of potential negatives to consider. While a fresh start may sound like a good idea, bankruptcy doesn’t go away for a very long time and can seriously impact your borrowing in the future.
Bankruptcy should be a last resort, saved for when you don’t have any other choice. Explore all your other options, such as debt consolidation and budgeting changes, before you decide to file.