When should you declare bankruptcy?

When drowning in too much debt, the idea of bankruptcy can seem like the only way out. However, there is a lot that people don’t know about bankruptcy—knowing all the information can help those weighing their options decide if it’s the best choice.

What Is Bankruptcy?

Bankruptcy is a process that helps people (or businesses) who cannot pay off their debts. The process gives them a fresh start by either liquidating their assets or helping pay off debts through a specific payment plan.

Individuals can file two different types of bankruptcy. Chapter 7 bankruptcy is an option that leads to liquidation. The other option is Chapter 13, which leads to adjusting existing debts. Whichever option is right for you, they’re both handled in federal courts under the guidelines laid out in the U.S. Bankruptcy Code.

How Do You Declare Bankruptcy?

If you feel like bankruptcy is your best option, there are a few steps you have to do before you’re able to file. First, you need to get all of your financial records together. This includes all your debts, assets, income, and other expenses. You also need to go through credit counseling within 180 days of when you plan to file. This counseling shows the court that you have done everything to avoid bankruptcy. It’s also required that you go to a counselor approved by the U.S. Courts.

After you’ve completed these prerequisites, you can file your petition. While it’s not a requirement, many financial advisors recommend hiring a bankruptcy lawyer, as it can be risky to represent yourself. Keep in mind that there will be many files and paperwork to go through, and this process can get lengthy.

What Are the Pros of Bankruptcy?

While bankruptcy can have a negative reputation, there can be some definite perks to filing if you have accumulated too much debt. For starters, you’re granted an automatic stay. This means that creditors cannot harass you for payments or take any more legal action against you. If you’re being called regularly over your late payments, you know how having that stop would be a huge bonus!

In addition, when you file bankruptcy, your debts will be settled for less than the amount you owe. This means that if you are required to make payments on your debts, it will cost you less than if you had handled them on your own. Some debts may even be written off entirely, so you never have to pay another dime on them!

Overall, bankruptcy gives you a fresh start on your finances. You can start over when it comes to rebuilding your credit and financial health. If you’ve been overwhelmed by debt for months or even years, the idea of starting over can be enough to convince you that bankruptcy is your best option.

What Are the Cons of Bankruptcy?

Of course, bankruptcy can have adverse effects as well. When deciding if this is the right step, it’s essential to know the risks you’re taking on. For starters, you may lose your valuable assets. Depending on their value, people have lost their homes, cars, or other items they own. This all depends on what type of bankruptcy you file, your income, and the equity in those items. 

You also need to know that filing bankruptcy isn’t free. You have to cover all of the court fees and any associated filing costs. According to the American Bankruptcy Institute, Chapter 7 bankruptcy can cost between $1,309 and $1,414 on average. Chapter 11 usually runs filers around $1,809. If you’re considering bankruptcy, this extra money can be hard to come by.

Another con to filing bankruptcy is that it won’t cover any outstanding federal student loans. However, your payments can be lowered for three to five years while going through the process. Just know that you shouldn’t expect to be relieved from those loans.

It’s also important to know that a bankruptcy will stay on your credit report for ten years. While its effect will lower over time, it can still hinder you for as much as a decade. Some landlords won’t rent to anyone with a bankruptcy on their report, and it can even keep you from specific job fields. Bankruptcy is also a public record, so anyone you know can find out you’ve filed for it. Depending on how transparent you are with your finances, this could be a negative.

When Should You File for Bankruptcy?

Bankruptcy isn’t for everyone, but there are some situations where it can be highly beneficial. If you have many accounts in collections, bankruptcy can be a good choice. Filing will mean that those collectors aren’t allowed to harass you anymore, which can help lower the stress you have over your financial situation.

Bankruptcy is also a good option for anyone who has too much debt. If you have consumer debt that equals half (or more) of your income, bankruptcy can help you get out from under it. It can also help if it would take more than five years to pay off your debts, even if you took drastic financial measures.

What Are Some Alternatives to Bankruptcy?

If you aren’t sure that bankruptcy is your best option, there are some other steps you can take if you have accumulated too much debt. One of those options is debt settlement.

To pursue this, you have to be in default on your debt. You can either pursue this option on your own or hire a debt settlement company to handle it for you. This process can lead to agreeing with your creditor to pay less than you owe on your debt. However, any forgiven amounts must be claimed as income on your taxes, and the settlement will be part of your credit report for up to seven years.

Another option instead of bankruptcy is credit counseling. This allows you to work with your creditors through a counselor to lower your monthly payments and interest rates. Plus, you must do this before filing for bankruptcy, so it’s a win-win.

Conclusion

Bankruptcy can be a big decision. If you have too much debt and have exhausted all of your options, consider taking steps to start filing for bankruptcy. Take into account the costs involved, and be aware of the damage to your credit score for the next ten years.

Recommended Readings:

When should you use a credit counselor?

Does refinancing hurt your credit?