Is Bankruptcy Bad? And Other Important Information About This Financial Step
At the end of 2019, around 70% of Americans reported struggling to be financially stable—and that was well before the COVID-19 pandemic caused economic issues for many.
When faced with collections, foreclosures and other financial stressors, many might wonder if bankruptcy is the right choice. But they don’t know: Is bankruptcy bad, good or neutral? Read on to find out more about bankruptcy for yourself.
What Is Bankruptcy?
Bankruptcy is a legal process that discharges some or all of your debt, which means the debts are no longer owed. But bankruptcy is far from a “clean financial slate,” though some people might refer to it as such.
Filing a petition for bankruptcy affords you some immediate financial protection, but it also puts a hefty negative item on your credit report. And filing for bankruptcy doesn’t automatically mean you’re off the hook for all your debts. How you continue to make payments—and how much you might still owe—depends on what type of bankruptcy you file.
In most cases, individuals file either Chapter 7 or Chapter 13 bankruptcy. Which one you file depends on your income, your debt and whether you have the disposable income to pay any portion of your debt back. Disposable income is what’s left over after you cover necessary living expenses such as food, shelter, medical care, education and utilities.
Chapter 7 Bankruptcy
Chapter 7 doesn’t require you to pay back a portion of your debt. During a Chapter 7 bankruptcy, much of your property is sold, and the proceeds are used to pay off as much of your debt as possible. Anything left over is discharged. To file for Chapter 7, you must meet income requirements, demonstrating that you don’t make more than a certain amount annually.
Chapter 13 Bankruptcy
In a Chapter 13 bankruptcy, you propose a payment plan that allows you to pay back a portion of the debt you owe. You can also keep assets such as homes and cars by making payments on them through the trustee or on your own. Chapter 13 bankruptcies require that you complete a payback plan that takes three to five years. At the end of that, your excess debts are discharged.
Cons of Bankruptcy
While bankruptcy is often held up as a clean-slate solution that lets you start over when finances have become stressful, it’s actually a different and potentially stressful process in itself. Here are some reasons that bankruptcy is a last-resort option for dealing with debt.
Giving Up Property
Is bankruptcy bad? It can be if you’re attached to your stuff. When you go through a Chapter 7 bankruptcy, the trustee is legally able to sell off many of your assets. The proceeds are then split between your creditors.
For example, the trustee may take a vehicle you own outright or one you’re still making payments on and sell it. They might also sell boats, art, jewelry, homes or other personal property—in short, Chapter 7 can make some pretty big changes to your lifestyle.
However, bankruptcy isn’t designed to leave you homeless or without any personal belongings. There are exemptions for certain amounts of equity in a home or car and personal belongings of various types.
Paying to File and Hire an Attorney
While you can file a bankruptcy petition on your own, it’s a complex process. And one misstep could mean your case is dismissed before it gets off the ground and you’re back at square one with your debt.
Because of this, it’s typically recommended that you work with an attorney to file your bankruptcy. How much that costs depends on which type of bankruptcy you’re filing and where you live. Many attorneys also charge extra for an emergency filing—which means the petition must be rushed because you’re facing imminent foreclosure.
In a Chapter 13, some of the legal expenses can be rolled up into Chapter 13 payments. But either way you file, you’ll probably have to come up with a couple hundred dollars or more to start working with an attorney—and if you’re filing bankruptcy, your finances probably aren’t in the best place to support that.
Damaging Your Credit Immediately
A bankruptcy is a big hit to your credit score. On average, people take between a 150- and 200-point hit when they file.
How much your credit might drop depends on a variety of factors, including how late you are with various payments. If you’re filing bankruptcy because you’re facing a foreclosure, for example, your credit score might already be dropping.
Pros of Bankruptcy
It’s not all bad news, though. While bankruptcy isn’t good, it might not be bad for your situation. Life can take unexpected turns, and a surprise job loss, medical emergency or other issue can leave you reeling financially. Here are some reasons bankruptcy might be the right choice in your situation.
Putting a Stop to Collections
When you file bankruptcy, something called an automatic stay goes into place. This is a legal requirement that, from the moment the petition is recorded with the clerk of court, creditors must cease collections activities against you.
That means a creditor can’t move forward with a foreclosure, repossession, garnishment or other type of collections activity. This can be a huge benefit because it gives you time to pull your finances together and make a plan of action for the future. The automatic stay is in place for the duration of the bankruptcy.
Erasing Certain Kinds of Debts
Both Chapter 7 and Chapter 13 can erase certain debts. Your bankruptcy trustee works to pay off as many of your debts as possible—or at least make partial payments on them. The funds for those payments comes from selling your assets or from your Chapter 13 payment plan.
At the end of the bankruptcy, it doesn’t matter if there wasn’t enough to pay all creditors the total balance they were owed. In fact, it’s expected that there won’t be. Instead, the trustee disburses payments according to priorities, with secured and priority debt—such as tax debt—being handled first. Whatever is left of your debts is effectively erased in most cases.
It’s important to note that only debts that are included in your bankruptcy filing are impacted. If you forget or leave out a debt for any reason, that creditor doesn’t have to comply with the automatic stay and the debt won’t be erased.
Helping Your Credit in the Long Term
In the long run, bankruptcy can actually help you positively impact your credit. That’s because bankruptcy offers you a reset of sorts and puts you in a position where you can better afford the bills you do keep.
By using bankruptcy as a true reset and moving forward with strong financial habits, you can make positive steps such as paying on time and carrying appropriate balances on credit cards. Your bankruptcy filing will have less impact on your credit over time—even though it stays on your report for up to seven or 10 years—and these new habits will have more impact.
How Many Times Can You File Bankruptcy?
There isn’t a limit on how many times you can file for bankruptcy, but you can’t receive unlimited debt discharges. That means if you previously filed a bankruptcy and it was successful, you might have to wait to file again.
- After a Chapter 7 discharge, you can’t receive another Chapter 7 discharge for eight years. You can’t successfully enter a Chapter 13 bankruptcy for four years.
- After a Chapter 13 discharge, you can’t successfully enter another Chapter 13 process for two years. In some cases, you may need to wait four years to receive a Chapter 7 discharge.
Deciding Whether Bankruptcy Is Right for You
Whether or not bankruptcy is right for you is a personal choice. Bankruptcy is bad for your credit and immediate financial situation. but if you’re already facing economic stress and hardship, bankruptcy might be better for your situation than other options.
If you’re not sure whether bankruptcy will be beneficial enough to outweigh the cons, talk to a bankruptcy attorney. Many offer free consultations to help you understand if you’re a candidate for Chapter 7 or Chapter 13 bankruptcy.
from a Credit Expert