It’s a decision that can change your life. Declaring bankruptcy and opting for a fresh start can lift the weight from your shoulders, but it comes with a price. On the other hand, you can soldier on trying to pay off your debt but risk falling further and further behind with payments. Family members will have opinions on your financial situation and so will friends. But ultimately the only decision that matters is your own.
If you are deciding whether bankruptcy is right for you, we are here to help. This guide and the rest of the content on our website will provide you with everything you need to know about bankruptcy, how it works and what to expect. The choice is still yours, but this guide can help you make as informed a decision as possible.
Understanding bankruptcy
The first step in filing for bankruptcy is understanding how the system works. Under the Bankruptcy Code, individuals have two choices—Chapter 7 and Chapter 13. Which one you choose will depend on your financial situation, any assets you wish to keep, and whether you want your debts to be resolved quickly or over several years. We have dedicated guides to both Chapter 7 bankruptcy and Chapter 13 bankruptcy, but you can find an overview of each below.
Chapter 7
Chapter 7 is a straight or liquidation bankruptcy that will wipe out your debts over a three to six month period. All of your assets (your house, your car, your company, etc.) are liquidated and the cash raised is distributed to your creditors to pay off as much of your debt as possible. Chapter 7 isn’t available to everyone, however. To be eligible for Chapter 7 you must have income less than or equal to your state’s median income, or pass the Chapter 7 means test.
Chapter 13
Chapter 13 is a reorganization bankruptcy that resolves your debts over several years. You are allowed to keep your assets on the condition that you pay creditors an amount that is at least equal to the value of your assets over a period of three to five years. This may seem challenging, but anything not paid off is automatically discharged. Chapter 13 bankruptcy is much easier to qualify for, too. You’ll need to prove that you can meet a repayment plan, obviously, and your debts can’t extend into the millions of dollars. Apart from that, you should be eligible.
Reasons to file for bankruptcy
There are many reasons to file bankruptcy and some are better than others. Wanting to avoid paying your student loan is not a good reason, for instance, but all of the following are:
- Your wages are being garnished. Filing for bankruptcy can stop wage garnishment and can even get back some of the money you have paid.
- You have unpaid medical bills. Bankruptcy can give you time to repay medical bills not covered by insurance or discharge them completely.
- You own no or few assets. You can only file for Chapter 13 bankruptcy if your assets don’t cover your debts. If so, you may be able to file for bankruptcy and keep them.
- You have been sued. Filing for bankruptcy can stop plaintiffs from obtaining judgments against you.
- You have cut back, worked multiple jobs and still can’t cope. If your debt is still mounting despite doing your best to pay it off, bankruptcy can stop debt from escalating out of control.
- Your home is in danger of foreclosure. A bankruptcy’s automatic stay can stop or delay the foreclosure process.
- You are using retirement savings to pay off bills. Your 401K and other retirement savings can’t be touched by bankruptcy so you should declare immediately.
To be clear, not every kind of debt can or should be solved with bankruptcy. As we will discover later, some debts like child support don’t qualify for bankruptcy. It also isn’t worth declaring bankruptcy to clear small amounts of unsecured debt or if you have no assets and no income. In both circumstances, it is unlikely that they will be able to make you pay quickly, even if they sue you.
Other solutions to consider
Bankruptcy isn’t your only option if you are struggling with debt, in fact, it should be your last resort. Try some of the solutions listed below before committing to bankruptcy.
Earning more or cutting expenses
It’s nobody’s dream to take on a second or even a third job, but if doing so means you don’t have to file bankruptcy it’s a no-brainer. Similarly, you should try reducing your outgoings and sticking to a budget before deciding that you can’t pay off debts.
Negotiate with your creditors
By filing for bankruptcy, there’s a chance your creditors won’t get the full amount they are owed. Knowing that, they may be willing to negotiate a settlement.
Seek professional advice
If you can’t or won’t try to get a settlement yourself, a professional credit counselor may be able to help. These experts know the right things to say to creditors and can reduce interest rates even if they can’t settle. If you are planning on filing for Chapter 7 bankruptcy you will have to get credit counseling before you can file in court, so you may as well start today.
Do you and your debts qualify for bankruptcy?
One of the great myths of bankruptcy is that it wipes out all debts. It doesn’t. The debts below are called priority obligations and can’t be wiped out:
- Student loans
- Child support
- Alimony
- Court fines
- Income tax debt
If you were thinking of declaring bankruptcy to discharge any of these debts, speak to a credit counselor or try one of the alternative solutions listed above.
How to avoid having your case dismissed
Dismissal occurs when a judge or trustee tosses out your bankruptcy case. It can happen for many reasons that we detail in our post on bankruptcy dismissal, but most occur because of incorrectly filed paperwork or because individuals try to cheat the system.
The best and easiest way to avoid your case getting dismissed is to hire a bankruptcy solicitor. Not only will they handle the paperwork on your behalf—and take liability for doing so correctly—they can also advise on the right type of bankruptcy for you and the obligations that it entails.
You may want to delay declaring bankruptcy
Even if bankruptcy is the right decision for you, now may not be the right time to declare. If any of the below scenarios sound familiar, waiting a few months can help you get the most out of your bankruptcy.
You recent income has been unusually high
When the court means tests your eligibility for Chapter 7 and Chapter 13, they do so by averaging your income over the last six months. So, while you may not be eligible for Chapter 7 right now if you recently lost your job, you may be eligible in a few months time.
You can sell assets yourself
If you are filing for Chapter 7 bankruptcy, you will probably be able to get more money for your assets by selling them yourself rather than letting the court do it. You can then use this money to pay more of the debt down or buy exempt assets.
You are expecting a large debt
The list of debts that you submit when filing for bankruptcy is final, and you won’t be able to add any more. If a new is on the horizon, you will be better off waiting until you are charged to declare bankruptcy. Don’t take this as an invitation to lease an expensive new car or incur other frivolous debts, however. If the court considers that you have acted irresponsibly, the debts may be upheld.
What assets can you keep?
The assets that you are legally allowed to keep will depend on the type of bankruptcy that you file.
In Chapter 7, several indispensable assets such as your home and car can be made exempt from the liquidation. Each state has its own laws on what value these exempt assets can hold, so consult a bankruptcy attorney for detailed information.
In Chapter 13, all assets are exempt just as long as you stick to the agreed repayment plan. To be clear, however, you must repay an amount that exceeds or is equal to the value of your assets. Failure to do so will result in asset liquidation.
Declare bankruptcy while you still have cash
Despite popular opinion, waiting until you have nothing left in the bank to file bankruptcy is not a good idea. Although you can do it yourself, many individuals choose to hire a bankruptcy attorney who will charge several thousand dollars. If this article has confirmed your suspicion that bankruptcy is the right solution for you, it may be sensible to stop paying unsecured bills in order to save money for an attorney. After all, if you declare bankruptcy soon, they won’t be able to chase you much longer.
Get a free evaluation before you file
It is important to understand all of your options when filing for bankruptcy. That means your first step should be to speak to a debt advisor to see if any other options, such as refinancing or settling your debts are suitable for you. Even if you have tried both tactics yourselves, these professionals have the tools and experience to settle. What do you have to lose?