Pros And Cons Of Filing Bankruptcy — Forbes Advisor – Forbes Advisor

Editorial Note: We earn a commission from partner links on Forbes Advisor. Commissions do not affect our editors’ opinions or evaluations.

Bankruptcy has long had a stigma in the U.S. People who file for bankruptcy protection have been stereotyped as irresponsible, unethical or lazy. But many Americans find themselves facing bankruptcy due to an unexpected crisis, like job loss, a medical emergency or divorce.

Bankruptcy is designed to give debtors a fresh start and provide relief from creditors. But filing for bankruptcy is a complex decision, and while it may be the best route for some, it’s not ideal for every situation.

Should You File for Bankruptcy?

If you’re overwhelmed with debt you can’t repay, or maybe your mortgage is underwater and you’ve exhausted all other options, filing for bankruptcy may be a wise decision.

Keep in mind that the degree of financial relief you receive from bankruptcy will depend largely on the type of debt you’re saddled with. Bankruptcy won’t discharge child support debt, most back taxes or other debt resulting from legal obligations. And, student loan debt is notoriously difficult to discharge, though the Department of Education recently indicated it’s considering whether to make bankruptcy an option for student loan borrowers.

A credit counselor can help evaluate your current financial situation and determine whether bankruptcy is the best course of action. Meeting with a credit counselor may end up being necessary anyway, as anyone filing for bankruptcy is required to receive credit counseling from a government-approved agency as part of the process.

You also should consult a bankruptcy attorney about whether to file. A lawyer can advise on which of your debts can be dealt with through bankruptcy, and whether to file Chapter 7 bankruptcy (known as liquidation bankruptcy) or Chapter 13 bankruptcy (known as reorganization bankruptcy).

If you decide to file Chapter 7, you must demonstrate eligibility through a means test, which evaluates your debt, expenses and income to determine whether you truly can’t afford to repay what you owe.

Pros and Cons of Filing for Bankruptcy

Pros

  • Bankruptcy offers a break from creditors. A significant advantage of bankruptcy is that it provides both temporary and permanent relief from creditors. An “automatic stay” prevents them from attempting to collect money from you while the bankruptcy is pending and provides temporary protection from foreclosure, eviction and car repossession. Later, if a debt is discharged through bankruptcy, debt collectors are no longer allowed to collect on it.
  • It protects future wages. Wages earned after your bankruptcy filing aren’t considered “property of the bankruptcy estate,” meaning your future earnings cannot be garnished to repay creditors for any discharged debt. However, your future wages may still be vulnerable to undischarged debt, like back child support or earnings committed in a payment plan for Chapter 13.
  • It can provide emotional relief. Juggling creditors can be exhausting, and financial stress can have significant impacts on your health and family. Bankruptcy can offer you some breathing room and a clean slate
  • You can keep some assets. Bankruptcy may require you to sell some assets to pay off your debts. But you won’t lose everything, because bankruptcy exemption laws protect your home, car, clothing and other valuables up to the dollar amounts listed below.

Federal Bankruptcy Exemptions

Cons

  • Bankruptcy destroys your credit. Your credit score indicates how likely it is you’ll repay debt, so bankruptcy can do tremendous damage to your credit. A bankruptcy will remain on your credit report for up to 10 years, but you can begin rebuilding your credit right away. You can start by taking out a secured credit card. If you file for bankruptcy, your credit probably isn’t in good standing, so the blow to your credit score may not be huge. If you still have decent credit, there may be alternatives to bankruptcy available to you.
  • It can be expensive. Filing fees for bankruptcy range from $313 for Chapter 13 to $338 for Chapter 7. Attorney fees vary but start at $1,300 for Chapter 7 bankruptcy and $3,000 for Chapter 13.
  • You may have to give up luxury items. While bankruptcy protects exempt assets, like your house and clothing, a Chapter 7 filing requires that any assets that do not qualify must be sold, to help pay off your debts. In Chapter 13 bankruptcy, you can keep your belongings, but the value of nonexempt, luxury assets is used to negotiate a repayment plan with your creditors.
  • It will be harder to borrow again. Having a bankruptcy on your credit report will dissuade lenders from extending credit in the future. You may be unable to obtain a loan until the judge discharges your debt. If you filed Chapter 7, must wait two to four years after your discharge before applying for a mortgage.

Alternatives To Filing for Bankruptcy

Sell Assets

Before any nonexempt asset is liquidated as part of a Chapter 7 bankruptcy, you may consider selling it on your own. You could get a higher price and use the extra funds to pay down debt.

Negotiate With Creditors

It may seem counterintuitive, but you can contact your creditors directly. This option works best early in the process before you are too delinquent, but later you could negotiate directly with the collection agency. Explain the circumstances and try to reach an agreement, which could provide you with a lower interest rate, reduced payments, a lump-sum payoff or a monthly payment plan.

Lenders are often willing to negotiate, since they’re likely to recoup more money than if you go through bankruptcy or your account is sent to collections. And debt collectors can be eager to negotiate because they’ve usually purchased your debt for pennies on the dollar. Regardless of the method you arrive at, make sure you get your agreement in writing. Keep a log of your conversations and detailed records of all payments made to your lenders.

You can negotiate for yourself, or turn to professionals for assistance. Nonprofit credit counselors can coach you through the process, but they rely on you to contact your lenders. Debt settlement companies, also known as debt relief agencies, will do the talking for you but often charge high fees, and not all creditors are willing to work with them. Many encourage you to stop making payments during the negotiations, but that can hamper the discussions.

Consolidate Debt

Reducing your interest rate could have a huge impact on your ability to repay debt, especially if you’re paying off credit cards or high-interest loans. If you’re early in the process and still have fair credit, you may be able to obtain a debt consolidation loan to cut your interest and consolidate your debt into a single payment.

Consider the scenario below in which the borrower has a high-interest car loan and two credit card balances that have been slapped with elevated interest rates because of missed payments:

The borrower above makes $695 in minimum debt payments each month. A 72-month debt consolidation personal loan could reduce the total monthly cost by $239 and save more than $4,909 in lifetime interest:

If our borrower continues paying $695 per month, not $456, they could be debt free in just over three years and save roughly $11,000 in interest.

When consolidating debt, you may want to avoid secured loan options like a second mortgage or a home equity line of credit (HELOC), because loans that use your house as collateral place your home at risk.

Find Out If You Qualify For Debt Relief

Free, No-commitment Estimate

Frequently Asked Questions (FAQs)

Can student loans be discharged through bankruptcy?

Some student loans can be discharged through the regular bankruptcy process, including: loans paid directly to the student that exceeded the cost of attendance; loans given to students attending school less than half time; and loans for schools not eligible for federal Title IV student aid funding. But in most cases you’ll also need to prove “undue hardship”—which can be difficult—and file a lawsuit called an “adversary proceeding.” The U.S. Department of Education is considering a policy change that would make it easier to discharge federal student loans in bankruptcy.

What’s the difference between Chapter 7 and Chapter 13?

Chapter 7 bankruptcy is designed for consumers who have no or low income, and you must prove you’re eligible to file by passing the means test. Many types of debt are completely wiped clean by Chapter 7. Chapter 13 bankruptcy is available to most filers with regular income and requires you to agree to a debt repayment plan that typically lasts three to five years. Once the repayment period ends, any remaining debt is often forgiven.

Can I file for bankruptcy if I’ve filed before?

If you filed for bankruptcy and your case was rejected, you must wait 181 day before you can file again. If you previously filed for Chapter 7 bankruptcy, you cannot file again for eight years. If you filed for Chapter 13, you cannot file again for six years.


Source