Pros and Cons of Filing Bankruptcy
Bankruptcy can provide relief from debt but will affect your credit score and ability to apply for credit. Learn about all the pros and cons of bankruptcy.
You may think of bankruptcy as either a disaster or a magic bullet that makes the consequences of bad financial decisions disappear. Unfortunately, it is neither of the two.
Bankruptcy is a legal process that allows those who have reached a financial crisis to get a second chance. It is costly, but if other debt relief options won’t work, it can be the only viable choice for those whose debts have become overwhelmingly burdensome.
When you file for bankruptcy, a court examines your assets and liabilities and determines whether you have enough assets or the financial ability to pay what you owe. If you can pay off your debt either in one lump sum or through monthly payments, your case may be dismissed. If not, some of your assets will be used to pay some of the debt, and the rest will be forgiven.
The purpose of bankruptcy is to give people an opportunity to start over while protecting creditors from having to pay the entire price for bad borrowing decisions.
There are several different chapters of bankruptcy in federal law that apply to individuals, businesses and even municipalities. For most individuals, there are just two choices.
Chapter 7 Bankruptcy is the most common type of bankruptcy with 69% of U.S. bankruptcy filings in 2021. This chapter of bankruptcy involves certain assets being liquidated to settle all or part of your debts. Some essential items dealing with home and work are exempt. Chapter 7 covers unsecured debts such as credit cards or personal loans, as well as medical bills, utility bills and civil court judgments that aren’t based on fraud. However, it will not eliminate child support, alimony, student loans and secured debts.
For applicants who have been approved for Chapter 7 bankruptcy, the process is usually over in four to six months, although it remains on your credit report for 10 years. However, not everyone qualifies. If the court determines you have enough income and assets to eventually pay what you owe, it’s unlikely to allow a Chapter 7 bankruptcy.
If denied for Chapter 7 bankruptcy, Chapter 13 bankruptcy may be an option. Chapter 13 bankruptcy holds 28% of 2021 U.S. filings, and is better suited for people who are way behind on their debts but have the income and assets to pay them with a little help. In Chapter 13, debts are reorganized, and you’re put on a program to pay what you owe. You have a time period of 3-5 years to pay off your debts under the supervision of a court-appointed trustee overseeing your payments. But the plan may keep you from having your house foreclosed or your car repossessed. If you have a steady income, haven’t recently filed for another bankruptcy and are up to date on your taxes, Chapter 13 may work for you.
Before choosing Chapter 7, Chapter 13 or neither, it’s important to know the pros and cons to bankruptcy.
Pros of Filing For Bankruptcy
- Stop the foreclosure on your home– When you file a Chapter 13 bankruptcy, foreclosure proceedings against your home are paused while a payment plan is developed to get you caught up on mortgage payments, including what’s past due. Another option is that a homeowner can decide to sell the house so the lender can receive what’s owed and the homeowner can keep any extra money the sale produces.
- Automatic stay– In both Chapter 7 and Chapter 13 bankruptcies, all creditors and collection agencies must temporarily stop harassing the debtor. Collection phone calls, letters, and the threat of lawsuits are stopped until the bankruptcy case is closed. This gives debtors the opportunity to improve their finances before collection attempts can resume.
- Prevent car repossession– By filing for Chapter 13 bankruptcy and making the car part of the court-approved repayment plan, creditors may not repossess the car. In Chapter 7 bankruptcy, the car is at least temporarily secured, but the creditor could go to court and receive an order that allows repossession.
- Potential to keep some assets– Bankruptcy includes the understanding that people need to keep certain essential items to be a productive part of society. Bankruptcy exemptions prevent certain items from being taken and sold to pay back the creditors. Which items are exempt depends in part on the state where you live. You may keep your car up to a certain value if you need a vehicle to keep working. If your vehicle is worth more than what your state considers to be exempt, it can be sold to pay creditors, but you receive the amount of the exemption in cash. Assets like veterans’ benefits, unemployment benefits and retirement accounts also may be exempt from bankruptcy.
- You’ll likely end up paying less than you owe – This is especially true in Chapter 7 bankruptcy, which potentially wipes out all your unsecured debt. Chapter 13 requires repayment of at least some of what you owe.
- Bankruptcy decisions are final – Once creditors agree to a deal, they can’t change their minds and ask for more.
- The court appoints a representative for you – That trustee works on your behalf and handles all contact with your creditors.
Cons of Filing For Bankruptcy
The pros may make bankruptcy seem like a good idea, but one should be aware of the problems attached to bankruptcy. The biggest downside to bankruptcy is that your credit score after bankruptcy is going to take a major hit. You could lose between 100 and 200 points and the score won’t bounce back quickly. It remains part of your credit record for up to 10 years, which is going to make borrowing during that time more difficult and expensive. One should expect higher interest rates. Unfortunately this is not the only downside to bankruptcy.
- The cost of filing bankruptcy – This may be news to you, but it’s going to cost you money to go through bankruptcy. The filing fees alone are more than $300. Attorney fees can range from $1,000 to $3,500 for Chapter 7 and $2,500 to $6,000 for Chapter 13 depending on where you live and the complexity of the case.
- Most student loans are exempt from bankruptcy – Unlike many debts, federal student loans can’t be discharged except in rare instances, such as severe medical conditions. Student loans are one of several debts that won’t be erased by bankruptcy. Others include alimony, tax debts and child support.
- The bankruptcy process is not quick – Although Chapter 7 bankruptcy can be over in 4-6 months, Chapter 13 lasts for a time period of 3-5 years. During that time, much of what you earn will automatically go to repay your creditors.
- Purchasing a home after bankruptcy is challenging– Even after your bankruptcy case is discharged, there are waiting periods before you can apply for a mortgage: from two to four years after Chapter 7, from one to three years after Chapter 13 except for FHA loans, which have no waiting periods.
- Buying a car after bankruptcy is also a challenging process – It’s possible to get a car loan but expect the interest rate to be higher. The longer you can wait while rebuilding your creditworthiness, the better deal you can get. Although the bankruptcy shows up on your credit report for seven to 10 years, it will be less of a penalty the last 3-4 years than it was the first few.
- Difficulty renting – Management companies and landlords may refuse to rent to those who have gone through bankruptcy.
- Career prospects – In some fields, bankruptcy can disqualify you from jobs where you might be considered a security risk.
- Embarrassment – Bankruptcies are public record, so your friends and co-workers may find out.
Should You Declare Bankruptcy?
Because there are many consequences of filing bankruptcy, there’s no good answer to whether it’s a good idea to file for bankruptcy. It should be considered a last resort because the consequences are significant and long-lasting.
Also, some actions essentially disqualify people from successfully seeking bankruptcy. If you’ve tried to game the system by taking out credit cards under different Social Security numbers, have been accused of intentionally defrauding creditors, recently transferred your home, car, and possessions to a relative or are about to inherit significant assets like a house or a lot of money, bankruptcy isn’t for you. As mentioned above, student loans usually can’t be discharged through bankruptcy, either.
Even if none of that applies to you, consider alternatives before taking the bankruptcy step.
Looking For A Bankruptcy Alternative? We May Be Able To Help.
Debt settlement involves negotiating an agreement so that your lender accepts less than what you owe to get your debt resolved. It’s not a quick fix, but you’ll pay less than you owe and avoid the worst consequences of bankruptcy.
If you are looking for an alternative to bankruptcy, consider hiring a debt settlement company. With debt settlement, a consumer pays less than what is owed. The payment is made via a lump sum after two or three years of saving for an amount large enough to make an offer. It requires a debt settlement company negotiating with one or more creditors to get them to agree to settle the debt for less than what is owed.