Lately, your monthly payments eat up almost everything in your paycheck. You’ve had to deplete your savings, and now you’re relying on credit cards to buy groceries. Your credit cards are roughly $5,000, and the monthly interest alone is over $100. For several months now, you have been only able to make the minimum required payments.
The repairs your aging vehicle needs, along with new tires, will add another $2,000 to the credit card balance. You have trouble sleeping because you know that you are falling behind financially, but you’re working full-time already and taking another job seems exhausting just to think about it. A friend suggested you file for bankruptcy and start over with a clean slate, but you don’t know what that means, how much it would cost, what would be the consequences, and whether you can really cancel all the debt that’s built up over the past few years.
Typical among those who must seek bankruptcy relief are those with debt where the creditors are suing for debt payment, those with a home in danger of foreclosure, paying for necessities with a credit card, using one credit card to pay another (a bad idea), and perhaps considering borrowing from your 401(k) account to pay bills.
Bankruptcy should only be your last resort, however. Before that you can consolidate loans and payments for a smaller total monthly payment. You can refinance and restructure debt in discussions with lenders. You can take that second job. You can sell things to raise cash. You can move to a cheaper place or get a cheaper vehicle. You can cut out all discretionary spending such as Starbucks, tickets to entertainment venues, travel, expensive clothes and shoes, and restaurants.
Let’s look at bankruptcy and what it is. Bankruptcy law (U.S. Bankruptcy Code) is a complex set of federal statutes, and bankruptcy proceedings are supervised and litigated in the U.S. bankruptcy courts. States do not regulate bankruptcy, though they may pass certain laws that govern aspects of the debtor-creditor relationship.
We will focus primarily on the individual, but listed above are all the bankruptcy statues, because you may also be an entrepreneur with excessive business debts. In personal bankruptcy, Chapter 7 and Chapter 13 are most common. Chapter 11 is also an option, although it is more frequently utilized for businesses. Chapter 7 bankruptcy is the liquidation of unsecured debts, for example credit card debt and medical bills, whereas Chapter 13 will allow the debtor to reorganize unsecured and secured debt into a three- to five-year repayment plan.
In most cases, any remaining debt will be eliminated at the end of that repayment period. However, both Chapter 7 and Chapter 13 have qualifying factors that must be met to file.
- Do you have other options?
- Which type of bankruptcy should you pursue?
- Does your debt (all or some) qualify for bankruptcy?
- Do you have assets you need protected?
- Must you hire an attorney?
- What are the consequences (including unintended) of filing for bankruptcy?
- What happens and what should you do immediately after bankruptcy?
- What lifestyle and financial changes should you make to avoid future bankruptcy?
Types of Bankruptcy
Chapter 7 Bankruptcy
This type is often called “liquidation bankruptcy.” It involves selling off the debtor’s non-exempt assets to pay creditors. Both individuals and businesses can file for Chapter 7. However, individuals must pass a means test to qualify. Once the assets are liquidated and creditors are paid, any remaining unsecured debts are typically discharged, giving the debtor that fresh start. While it can certainly be a fresh start, filing for bankruptcy comes with costs, depending on the size, type and complexity of your debt. Filing Chapter 7 bankruptcy typically costs between $1,800 and $2,300.Chapter 11 Bankruptcy
Known as “reorganization bankruptcy,” Chapter 11 allows businesses (and sometimes individuals) to restructure their debts and continue operating under court supervision. The debtor remains in control of the business operations, but must follow a court-approved plan to repay creditors over time. Chapter 11 is more complex and therefore more expensive than Chapter 7, making it more suitable for larger businesses.Pros
Once you file, an automatic stay goes into effect, which temporarily stops creditors from collecting debts, foreclosing on your home, or repossessing your car. Certain debts can be discharged, meaning you are no longer legally required to pay them. This can include credit card debt, medical bills, and personal loans. Depending on the type of bankruptcy, some of your assets may be protected from liquidation. As we mentioned, Bankruptcy can provide a fresh financial start by eliminating or restructuring your debts.Cons
Bankruptcy can significantly impact your credit score and remain on your credit report for up to 10 years, making it difficult to obtain new credit. In Chapter 7 bankruptcy, ‘liquidation,’ some of your assets may be sold to pay off creditors. Bankruptcy filings are public records, that means your financial situation will be accessible to the public. Certain debts, like student loans, child support, and most taxes, are typically not discharged in bankruptcy. Sometimes medical debt can be difficult to discharge as well.Summary
Deciding how to get out of debt and to begin rebuilding your financial future is quite personal. And there simply is no one-size-fits-all solution. The American Bankruptcy Institute lists three main causes: a) job loss, b) medical bills, and c) divorce. If you don’t have enough savings, one or more of these can torch your financial plans.The American Bankruptcy Institute reports personal bankruptcy filings increased from May 2022 to May 2023 over 23 percent. The resumption of student loan debts in the fall of 2023—along with the U.S. Supreme Court’s decision not to allow the Biden administration’s partial forgiveness plan—may result in the increase of financial stress and a higher percentage of bankruptcies. Debt has become excessive in America, in terms of national debt, business debt and personal debt. As interest rates increase, and if recession finally hits, you may find yourself in difficult financial straits. Knowing your options can help you plan how to navigate troubling financial times in your life.
