Should I file for bankruptcy?
Find out if bankruptcy is the right choice for you
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While bankruptcy is often seen as a last resort and carries heavy financial consequences, sometimes it is the only viable option to free individuals from crushing debt.
There are a number of reasons why you might seek bankruptcy. But Jen Lee, a bankruptcy attorney, says the most common reason she sees is a failed business.
“I also see a lot of people filing because of ‘lifestyle creep.’ People who have lost high-paying jobs but never change their standard of living often wind up in debt,” added Lee.
Others find themselves in financial despair after divorce or separation, natural disaster or unexpected expenses.
Whatever situation is causing you to consider bankruptcy, this guide will help you see if it’s the right option for you.
- Bankruptcy should be considered a last resort after you’ve tried all other options.
- Filing for bankruptcy can provide a fresh financial start by discharging certain debts and stopping creditor actions.
- Not all debts are dischargeable in bankruptcy, such as child support and certain tax obligations.
What is bankruptcy?
Bankruptcy is a legal process designed to provide individuals and businesses with relief from overwhelming debt. Certain types of debts, such as credit card balances, medical bills and personal loans, can be discharged through bankruptcy. However, not all debts can be discharged, including certain tax obligations and child support payments.
While bankruptcy can provide debt relief, it is not an easy solution. Filing for bankruptcy can have a significant impact on your credit score and financial situation for many years, making it difficult to get approved for a loan or mortgage.
Reasons for filing for bankruptcy
There are many different reasons why someone might seek protection from creditors through bankruptcy. While some people assume that being bankrupt means you have no money, the reality is much more complex.
Here are some of the most common reasons why a person or company files for bankruptcy.
- Medical debt
- Sickness or injury can lead to massive medical bills, even if you have a solid health insurance policy. Additionally, a medical situation may limit your ability to earn income while you recover or take care of someone else.
- Divorce can significantly affect your finances. Divorce attorneys can be expensive, and your share of joint debt can be overwhelming on one income or after accounting for spousal and child support.
- Job loss
- Whether you're living paycheck to paycheck or comfortably on your current income, your own job loss or a spouse’s job loss can wreak havoc on your finances.
- Judgment against you
- Getting sued is expensive when you factor in attorney bills, court costs and potential judgments against you or your business. Depending on the case, a judgment can exceed your insurance policy limits, net worth and ability to repay.
- Overbearing contract terms
- Some contract terms are so one-sided that you need a bankruptcy judge to help negotiate and rightsize the terms to make them more affordable for you. While this approach is primarily used by business owners, it can be applicable to consumers as well. For example, your rent is much higher than market rates, or your loan interest rate is so high that it qualifies as usurious.
- Failed business
- According to the online business resource Chamber of Commerce, nearly one in five small businesses fail in the first year, and 50% fail after five years. A business failure can leave you with substantial debt and no way to pay it back.
Filing for bankruptcy can carry a stigma, but it’s nothing to be ashamed of. In many cases, circumstances beyond your control can overwhelm your finances, and bankruptcy is the only reasonable path out.
When is bankruptcy the best option?
Bankruptcy should be pursued only after you have exhausted all other options and received financial counseling.
"I always recommend a debt strategy counseling session when someone is considering bankruptcy," Lee said. "I would say that only about 40% of my clients end up filing for bankruptcy."
Additionally, bankruptcy should be considered if it can save you from losing your home.
"Bankruptcy is a good option if you are expecting major events to occur due to your debt,” said Derek Jacques, a family law and bankruptcy attorney with The Mitten Law Firm. “Because bankruptcy puts a halt on collection actions, it also puts a hold on foreclosures, evictions and repossessions, at least for a time. Then you can use the exemption rules to help save your property from being seized.”
Alternatives to filing for bankruptcy
Filing for bankruptcy isn't the only option if you’re having trouble repaying your debt. Before going down this path, consider these alternatives.
- Get a debt consolidation loan. A debt consolidation loan pays off your existing debt and consolidates it into a loan with one monthly payment. A debt consolidation loan can potentially lower the interest rate on your debt or extend the term to reduce your monthly payment amount. The focus on gradually paying down the balance owed puts you on a path to being debt-free at the end of the loan term.
- Negotiate with your creditors. Contact your creditors to negotiate your interest rate, the amount owed and repayment terms. They may be willing to renegotiate your terms so you can avoid filing for bankruptcy.
- Open a balance transfer credit card. If you can qualify, apply for a balance transfer credit card with a low interest rate. Many of these cards offer promotional interest rates as low as 0% for 12 to 21 months, which can help you pay down your balance faster.
- Borrow from friends and family. Your friends and family may be able to gift or lend you money to take care of your debts. But keep in mind that this could cause problems in your relationship if you’re unable to repay.
- Sell your assets. Consider selling unused or rarely used assets and putting the proceeds toward paying down your debts. Downgrading your car or moving to a lower-cost home can also free up extra cash.
- Increase your income. You can put more money toward your debt if you boost your income by getting a second job or starting a side hustle. You may benefit from switching companies, particularly in a strong job market.
What is the downside of filing for bankruptcy?
One downside of bankruptcy is that it negatively affects your credit score and makes you less likely to be approved for financing for several years. Depending on your situation, you might also be required to liquidate certain assets to repay some of your debt. Going through bankruptcy is not just financially draining; it is emotionally draining as well.
How long will bankruptcy hurt me?
A Chapter 7 bankruptcy typically remains on your credit report for 10 years from the date of filing, while a Chapter 13 bankruptcy remains for seven years. However, it's important to note that the negative impact of bankruptcy on your credit score lessens over time.
Will I lose my house if I file for bankruptcy?
Not every bankruptcy leads to home loss. During a Chapter 7 bankruptcy, the bankruptcy trustee may liquidate your nonexempt assets, including your home, to pay off your debts.
However, most jurisdictions provide exemptions that allow you to protect a certain amount of equity in your primary residence. If your equity is within the exemption limits, you may be able to keep your home.
A Chapter 13 bankruptcy, on the other hand, allows you to keep your assets while entering into a repayment plan to catch up on missed mortgage payments.
- Article sources
- ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
- Chamber of Commerce, "Small Business Statistics." Accessed June 11, 2023.
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