Filing for bankruptcy can be a chance to eliminate a great deal of financial stress, put an end to collection calls and letters, and provide an opportunity to remake your financial life.
Even so, declaring bankruptcy is not something you should take lightly.
While bankruptcy can, in some cases, reduce or eliminate your debts, it also has serious consequences, including long-term damage to your credit score. That, in turn, can hamper your ability to obtain new lines or credit, and even make it difficult to get a job.
As you think about filing for bankruptcy, here are some things to consider.
What Does it Mean to File Bankruptcy?
For individuals, there are two main kinds of bankruptcy:
Chapter 7: Also known as “liquidation bankruptcy,” this is bankruptcy in its most basic form. With this type of bankruptcy, your nonexempt possessions, such as homes and cars, are sold to repay existing debts. After this, many (if not all) of your debts are canceled outright in a four- to six-month process.
Chapter 13: Also known as a “reorganization bankruptcy,” this is a court-approved plan in which you use your income to make payments on your debts over a three- to five-year period. Some of your debts may also be discharged.
The main difference between the two options is that Chapter 7 allows the debtor to eliminate all dischargeable unsecured debt, whereas Chapter 12 allows for payments to be made on those debts.
You may be prevented from filing for Chapter 7 bankruptcy if you earn enough income to repay your debts in a Chapter 13 bankruptcy plan. On the other hand, you may not qualify for Chapter 13 bankruptcy if your debts are too high or your income too low.
Some debts, like child support obligations, alimony, student loans, and some tax obligations, cannot be wiped out in either type of bankruptcy.
Also, bankruptcy won’t relieve you of your obligation to pay your mortgage, though it might make your mortgage payments easier to make by getting rid of other debts.
If you have substantial equity in your home, you could potentially lose it if you file for Chapter 7. If you file for Chapter 13, you can keep your home and pay off any mortgage arrears through your repayment plan.
Chapter 13 bankruptcy stays on your credit report for seven years, while Chapter 7 bankruptcy stays on the report for 10 years.
When To Consider Bankruptcy as a Solution
Life circumstances and financial situations can vary significantly from person to person, so there is no hard and fast rule for when to declare bankruptcy.
However, you may want to start by asking yourself the following questions:
• Are you unclear on exactly how much you currently owe?
• Are you only able to make minimum payments on your credit cards?
• Are you getting calls from debt collectors?
• Does the idea of solving your financial problems make you feel hopeless, out of control, or scared?
• Are you using your credit card to pay for necessities?
• Are you thinking about debt consolidation?
If you answered yes to two or more of these questions, you may want to at the very least give your financial situation more thought and attention.
You may also want to start doing some research (or, if possible, speak with a consumer law attorney) to see if your debt qualifies for bankruptcy, as well as how filing for bankruptcy would affect your life and financial situation.
Alternatives to Bankruptcy
While bankruptcy can sometimes be the best way to get out from under crushing financial burdens, it is not the only way. There are alternatives that can often reduce your debt obligations without some of the negative consequences of bankruptcy. Here are a few you may want to consider.
A counselor or counseling service specializing in helping people with debt problems might be able to come up with a solution that has not occurred to you, such as a modified payment plan or debt consolidation.
According to the Federal Trade Commission , you’ll want to look for a nonprofit credit counseling program, such as those offered by universities, military bases, credit unions, housing authorities, and branches of the U.S. Cooperative Extension Service.
You can also find a nonprofit agency that offers bankruptcy counseling through the National Foundation for Credit Counseling .
You may also want to keep in mind that not all not all nonprofit organizations offer free services, so it’s a good idea to do your research before you sign up for counseling services.
Negotiating with your Creditors
Creditors would often rather settle a debt with you than have it discharged in bankruptcy. Debt settlement is an agreement between you and your creditors that you will pay a lump sum, possibly far below what you owe, in order to settle the matter.
But it may not be quite as lovely as it sounds. The creditors take a loss, and likely so will your credit score. You’ll also still need to pay taxes on the forgiven amount, because it will be considered revenue (money you’re getting back).
There are debt settlement companies out there to help you negotiate with creditors, but not all of them are created equal—some of them charge steep fees and can’t guarantee they will get you the settlement that makes the most sense for you.
It’s a good idea to carefully vet any debt settlement company you are considering working with.
Cutting Back on Expenses
You may want to give some deep thought to the way you live and currently spend your money. Your lifestyle and financial habits may be what inched you toward bankruptcy in the first place. A good way to start is to set up a personal budget, which involves looking at what’s coming in and what’s going out each month, and then looking for places to trim spending.
Even small steps, like making your own lunch, walking instead of burning gas, keeping the heat or air conditioning use to a minimum, and brewing your own coffee could help you free up money that can go toward paying your debt.
While it can be tough to live on a budget at first, with time, you may find yourself becoming more solvent and less burdened.
With debt consolidation, you roll all your debts into one new loan account, preferably with a lower interest rate. This can enable you to pay off your past-due amounts and make one monthly payment going forward.
Having just one payment may make it easier to manage your existing debt, and could possibly save you on interest as well.
Refinancing or Modifying Your Mortgage
If your credit is still good enough, you may be able to refinance your mortgage to a new rate that could get your monthly payment low enough that it saves you from bankruptcy.
If you’re not able to refinance at a lower rate, you may be able to qualify for a mortgage modification. A mortgage loan modification is a change in your loan terms that could reduce your monthly payment.
If your lender allows it, it could involve extending the number of years you have to repay the loan, reducing your interest rate, and/or forbearing (or reducing) your principal balance.
You may want to keep in mind, however, that if you receive a loan modification and you still can’t make the payments, you could be at risk of losing your home
If you have large debts that you can’t repay, are behind in your mortgage payments and in danger of foreclosure, and/or are being harassed by bill collectors, declaring bankruptcy might be a good solution.
Bankruptcy can help you get out from under crushing debt. The process involves either liquidating (or selling off) your assets to pay your debts or adhering to a court-ordered repayment plan.
However, bankruptcy comes with consequences. The information stays on your credit report for seven to 10 years. It can also make it difficult to get credit, buy a home, or sometimes get a job.
Before considering bankruptcy, you may want to first explore other debt management options.
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