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Bankruptcy is a legal option that can provide relief for people who can no longer keep up with their debts. While this route can alleviate an excessive financial burden, there are pros and cons of filing for bankruptcy. For instance, while it can provide you with a fresh start, it can make it difficult to be eligible for new forms of credit down the road.
The decision to file for bankruptcy should be considered carefully, weighing not only the benefits and the potential relief it can bring but also the drawbacks. So, what are the pros and cons of filing for bankruptcy?
There are a lot of misconceptions about what it means to file for bankruptcy, which can lead to unnecessary stigma.
For instance, there is a commonly held belief that those who file for bankruptcy are irresponsible when it comes to managing money. In reality, the high cost of medical expenses is one of the leading causes of bankruptcies.
Other misconceptions are that if you file for bankruptcy, you can lose all of your belongings or never be eligible for credit again. Neither of these statements is true. Your assets are often protected by federal or state exemption laws — though you may have to sell some of your belongings in a Chapter 7 case — and many bankruptcy filers are able to secure forms of credit again.
There are six types of bankruptcy, but the average consumer will usually file one of two:
- Chapter 7: This is the most common form of bankruptcy for individuals. With this method, valuable assets are liquidated to settle debts. Chapter 7 is typically split into asset cases and no-asset cases; if you are determined to be a no-asset filer, you won’t have to give up your belongings. Chapter 7 bankruptcy can stay on your credit report for up to 10 years, starting on the filing date.
- Chapter 13: This is the second most common form of bankruptcy that individuals file. With Chapter 13 bankruptcy, a three-to-five-year repayment plan is created. This form of bankruptcy can stay on your credit profile for up to seven years.
- The type of bankruptcy you qualify for may depend on your income and the value of your assets. For example, to see if you qualify for Chapter 7 bankruptcy, you’ll have to take a means test to determine your eligibility. If you’re not eligible for Chapter 7, you may have to file for Chapter 13.
Filing bankruptcy: The Good
While it shouldn’t be undertaken lightly, bankruptcy can be a much-needed life raft for consumers who are drowning in debt. Here’s a look at some of the benefits of filing for bankruptcy.
You’re granted an automatic stay
The instant you file, you are protected under a provision in bankruptcy law called the automatic stay. Creditors cannot pursue payment of your debts or take other actions against you until the bankruptcy is discharged or a repayment plan has been finalized.
You’ll get relief from dealing with multiple creditors
Filing bankruptcy can mitigate the pressure and overwhelming nature of handling numerous creditors. In fact, you may experience immediate relief once your debts are discharged and you no longer have to repay some or all of your financial obligations.
You’ll receive a court-appointed representative
Once you file your petition for bankruptcy, you’ll be assigned a trustee who will see your case through to discharge. They will operate on your behalf throughout the process, including handling all communication between you and your creditors, and in the case of Chapter 13 bankruptcy, they will be the one to receive and process your payments.
Bankruptcy can prevent further legal action
One of the largest benefits of bankruptcy is that you could be legally cleared of responsibility for your debt. On top of that, it could potentially prevent any future legal trouble related to the nonpayment of that debt. Keep in mind that not all debts are dischargeable, but most forms of unsecured consumer debt can be wiped out in bankruptcy.
You may be able to keep some assets
In Chapter 13 bankruptcy, you are likely to be able to keep your assets as you repay your debts, but even when your assets are liquidated under Chapter 7, some valuables may be protected by federal or state exemption laws, depending on where you live.
Some back taxes can be addressed
Filing bankruptcy can be an effective way to deal with back taxes, especially in a situation in which wages are being garnished. While most tax debts cannot be dismissed in bankruptcy, some older tax debts can be discharged. To be eligible, your tax debts must be at least 3 years old and must be income taxes. Fraud penalties and payroll taxes are never eligible for discharge.
Bankruptcy may prevent home foreclosure or car repossession
Chapter 13 bankruptcy can be a tool to delay or stop a foreclosure or car repossession. You may also be able to keep your vehicle if it is covered under exemption laws.
For example, a federal exemption allows you to have up to $4,450 in equity for your vehicle. If your vehicle is worth $4,000, for example, you may be able to keep the car because it falls under a federal exemption.
Your debts may be settled for less than what you owe
Your creditors will be forced to accept whatever payment is determined in your bankruptcy case, which sometimes means receiving no payment at all. If you qualify for a Chapter 7 bankruptcy, you could have all of your unsecured debts dismissed, including credit card debt, personal loans and medical debt.
However, Chapter 13 bankruptcy can be trickier because you may have to repay some of those debts over the course of three to five years.
Some debts will be completely written off
Once your bankruptcy case is closed, any debts that are discharged are gone for good. Your creditors cannot come back and try to collect on any debts that were dismissed during bankruptcy.
Bankruptcy could potentially increase your credit score
It’s no secret that bankruptcy can hurt your credit. But if your credit score wasn’t great before you filed for bankruptcy, you could potentially see an increase after your debts are discharged. Debt elimination could help lower your credit utilization ratio, which is one of the factors that determine your credit score.
You can take on new credit after your debts are discharged
The process of rebuilding your credit after bankruptcy can start immediately after your debts are discharged. In some cases, individuals are approved for credit cards almost immediately after they receive their discharge order. You will face some limitations as you attempt to take on new credit, however, especially since your credit score is likely to be low. A good place to start may be a secured credit card.
You’ll get a fresh start
Bankruptcy can potentially provide you with a much-needed clean slate to begin rebuilding your financial life. This new start can help consumers reestablish their credit and build healthy habits around money.
Filing bankruptcy: The Bad
Of course, filing bankruptcy also comes with many drawbacks. Given the complex nature of the process, we recommend contacting an experienced bankruptcy attorney to assist with your case.
You could lose assets of value
Depending on which type of bankruptcy you qualify for, your income, the equity in your assets and other factors, you may lose your home, your car and other valuable items. Your trustee may be required to sell these items to repay your creditors.
Bankruptcy can be expensive
You’ll need to cover the costs of bankruptcy, including service and court fees. The average Chapter 7 bankruptcy case costs between $1,000 and $1,750 in out-of-pocket costs, while the average Chapter 13 bankruptcy costs around $3,300.
Federal student loans are exempt from bankruptcy
In most cases, federal student loans are not dischargeable; there are some exceptions, but they are rare. Instead, if you’re struggling to keep up with your federal student loan payments, you may have to look into forbearance, deferment or income-based payment plans.
You may still be responsible for some debts
While most debts can be discharged, there are some debts you will still be responsible for repaying. Besides federal student loans, certain other liabilities are not dischargeable, including taxes, alimony, child support, court orders and debts incurred through illegal activity.
If you have joint accounts, the other party is still responsible
Creditors can demand payment from the nonbankrupt debtor or any cosigners you have. This is an important factor to consider before adding a co-applicant to a credit application, and you’ll want to be sure your co-borrower understands this as well.
You could face criminal charges if you aren’t honest
The information you provide when filing for bankruptcy will be scrutinized. If you provide inconsistent or false information, you could face legal action. It is in your best interest to be completely honest about the assets you own and any income you receive.
Bankruptcy is a long process
A Chapter 7 bankruptcy moves pretty quickly and typically discharges within a few months after filing. A Chapter 13 bankruptcy, however, is a much longer process since you’ll have to follow a three-to-five-year payment plan before your case is discharged.
You could lose your business
If you own a business and the trustee in your case determines it has value, you could be forced to sell it. In some instances, the trustee may operate the business until the sale is complete.
You may face eviction
If you rent your home and are behind on your payments, you could be forced to leave the property once the bankruptcy is discharged. However, if you are current on your rent payments, it is uncommon to be evicted over a bankruptcy filing.
You’re likely to have trouble renting in the future
You could experience difficulty renting a home after declaring bankruptcy, as some landlords or management companies may automatically reject prospective tenants who have a bankruptcy in their credit history.
Bankruptcy can impact your job or career
Bankruptcy may disqualify you from holding certain positions, though it’s rare for this to happen. Filing for bankruptcy is most likely to cause trouble for those who work with money, including jobs in accounting or payroll. When you apply for a new job, a potential employer could see your bankruptcy filing during a credit check for employment since it’s public record.
Your bankruptcy will be made public
Bankruptcies are publicly reported, so people you know could potentially discover that you filed. This includes if someone runs a background check on you for employment or housing.
Your trustee may continue to administer your assets after discharge
Depending on the specifics of your case, the trustee may pursue the sale and distribution of your assets after your debts have been discharged. This can include any assets and income acquired within 180 days of the discharge, such as an inheritance or divorce settlement.
Your credit score is likely to drop
Depending on your credit score before filing, you could see a significant drop. If you had a good credit score before you filed for bankruptcy, you may see a pretty big drop. However, if your score is already low, there may not be much of an impact on your credit score.
You’ll experience difficulty gaining future credit
Your bankruptcy will follow you for quite some time. Chapter 13 can stay on your credit report for up to seven years, while Chapter 7 can remain for up to 10 years. If you apply for a form of credit and the lender runs a credit inquiry, it will be able to see your bankruptcy and may not approve your funding request.
You’ll receive high interest rates and low credit limits
Even though you may qualify for new credit after filing for bankruptcy, it may come at a premium. You’re more likely to be charged high interest rates, as creditors may see you as a risky borrower, and you may only be eligible for low amounts of credit.
You’ll have to wait to purchase a home
Before you can qualify for a mortgage, you’ll have to wait anywhere from one to four years, depending on the type of mortgage. If you file for Chapter 7 and plan to apply for a conventional mortgage, the waiting period is four years. With a Chapter 13 bankruptcy, you’ll have to wait two years from your discharge date.
Your car insurance premiums will go up
Car insurance companies use an industry-specific credit report based on your credit file, so if you need to secure auto insurance after filing bankruptcy, your rates will likely be impacted.
Bankruptcy stays on your credit report for up to 10 years
Your bankruptcy will remain on your credit report for up to 10 years from the date of discharge. While the impact will lessen over time, it can play a factor in any financial moves that require credit inquiries.
It doesn’t address the cause of your financial trouble
While bankruptcy can be a solution in certain circumstances, it doesn’t fix what led to the problem in the first place. Without a solid plan in place, you could repeat your mistakes and end up needing to file bankruptcy a second time.
It cannot be undone
Bankruptcy is final. You cannot change your mind once your case is finalized. This is why it’s important to fully understand what you’re signing up for when you decide to file for bankruptcy. Credit counseling — which is required when filing for bankruptcy — can help you determine whether it’s the right move for you.