When debt becomes so crushing, bankruptcy is the last resort, and although it may give you a fresh lease on life, it can be very damaging. You can be well-informed about what bankruptcy is, what kinds of bankruptcy are out there, who is eligible and what your options may be if you’re thinking about filing for bankruptcy. What bankruptcy can do for you as a debt remedy: Here is a brief primer.
What is Bankruptcy?
Bankruptcy is a legal procedure to discharge or pay off debt under the supervision of a bankruptcy court. By going bankrupt, creditors can no longer pursue you with lawsuits, wage garnishments, or repossessions. But it’s a massive jump to make only after everything else has failed because it lasts for a very long time in your financial future.
Types of Bankruptcy for Individuals
For people, bankruptcy has two main forms, Chapter 7 and Chapter 13. There are qualifications, procedures and results for each.
1. Chapter 7 Bankruptcy (Liquidation)
– Description: Chapter 7 (aka “liquidation bankruptcy”) is used to wipe out the majority of unsecured debts like credit card balances, medical bills, and personal loans. During the sale, part of your assets will be sold to pay off debtors.
– Eligibility: To qualify, you have to take a “means test” which compares your income. You may be able to claim Chapter 7 if your income is below the state median or you have very little in the way of savings.
– Procedure: After filing, a trustee is appointed to manage your case and liquidate non-exempt assets to settle creditors. After that, the majority of your unsecured debts are forgiven.
– Effect: Chapter 7 usually appears on your credit report for 10 years which has major impact on how much credit and loans you can get in the future.
2. Chapter 13 Bankruptcy (Reorganization)
– Context: Chapter 13 (or “reorganization bankruptcy”) will let you keep what you own and implement a repayment plan to repay part or all of your debt over the course of 3 to 5 years.
– Qualifications: Chapter 13 is only for regular earners who qualify for certain debt amounts. Chapter 13 might be the answer if you are stable in income but want to make payments but need help with payment.
– Repayment Plan: You’ll agree with the court to a plan of repayment based on income and debt. When the plan is complete, unused credit lines are forgiven.
– Consequences: Chapter 13 is a 7 year stay on your credit report and you keep most or all of your assets. It could be less damaging than Chapter 7 because you are paying at least some of the debt back.
Pros of Bankruptcy
1. Relief From Debt: Bankruptcy can pay off or discharge most of your debt and relieve you from financial worries.
2. Automatic Stay Protection: When you go bankrupt, an automatic stay automatically protects you from collections from creditors through lawsuits, wage garnishments and harassing.
3. New Life: With bankruptcy, you can start over from the beginning, if you’re in extreme debt.
Cons of Bankruptcy
1. Impact on Credit: Bankruptcy negatively affects your credit score and stays on your report for 7-10 years and will affect how much money you can borrow, obtain credit and even lose a job.
2. Disposal of Assets (Chapter 7): If you file under Chapter 7 bankruptcy, you might have to give up some of your assets in order to pay creditors.
3. None of These Debts Are Cancelled: There are some debts that are generally not canceled, such as student debt, alimony, child support and taxes.
4. Costs and Fees: Bankruptcy is expensive with filing fees, attorney fees, and more.
Alternatives to Bankruptcy
Since bankruptcy can hurt your financial health in the long run, you will need to think about other debt relief first. Alternatives include:
- Debt Settlement: Working with creditors to settle the debt for you usually with a debt settlement company or lawyer.
- Debt Management Plan (DMP): Negotiate a payment plan through a credit counseling agency at a flexible rate.
- Debt Consolidation: Pooling multiple debts in one low interest rate loan, easier to pay off.
Is Bankruptcy Right for You?
Bankruptcy may be appropriate if:
– You’re in so much debt you won’t be able to pay it back in 5 years.
– You have tried every other form of debt management, consolidation, settlement and management plan.
– You’re under the thumb of aggressive collection efforts like lawsuits or garnishments, and want legal help.
Preparing for Life After Bankruptcy
Even if you declare bankruptcy, you can still make it work so that your finances can be restored:
1. Make a Budget: Make a realistic budget so that you won’t end up in debt.
2. Create an Emergency Fund: Keep a little money in the bank every month to save up for the unforeseen and never be a credit-carrying person.
3. Rebuild Your Credit Slowly: Apply for a secured credit card and pay it in full every month and with a small balance to build your credit over time.
The debt solution of bankruptcy is an effective one, but you don’t do it lightly. It can be a reset for those who are severely broke, but its long-term effects on credit and your personal finances should be weighed. Talk to a financial adviser or bankruptcy lawyer to determine what your options are and whether bankruptcy is right for you.