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Should You File Bankruptcy?

Find out if bankruptcy is the right move for you – plus, learn the 5 most common bankruptcy myths you should ignore

By
Laura Adams, MBA,
November 30, 2011
Episode #244

bankruptcyIf you’ve ever been over your head in debt, you may have wondered whether you should file bankruptcy.  I’ll tell you the advantages and disadvantages of declaring bankruptcy, the truth about 5 common myths, and when bankruptcy might be the right decision for you.

What is Bankruptcy?

Bankruptcy is a system of federal laws that allows individuals and businesses to get relief from debts so they can make a fresh financial start. It was created to help an honest, but unfortunate, debtor forge a new future without pressure from creditors trying to collect pre-existing debts.

What are the Types of Bankruptcy for Individuals?

The most common types of bankruptcy for individuals are called chapter 7 and chapter 13:

  • A chapter 7 bankruptcy liquidates all your non-exempt assets to pay off creditors. It’s generally the best option when you have a large amount of unsecured debt, like medical bills and credit cards, and little income.
  • A chapter 13 bankruptcy reorganizes or adjusts your debt using a repayment plan. It’s the best option if you have income, but want to avoid foreclosure of your home, or need time to catch up on outstanding debts.

Advantages of Filing Bankruptcy

The immediate advantage of filing bankruptcy is an “automatic stay,” which puts your creditors on notice that they have to stop trying to collect money from you. The stay prohibits creditors from calling you, sending collection letters, filing lawsuits, garnishing your wages, or seizing any of your assets, except in a few cases, such as in the collection of alimony and child support.

If you have a successful bankruptcy case, the court will issue a discharge of certain debts, which means you won’t have to repay them.

Disadvantages of Filing Bankruptcy

Making your creditors disappear sounds like a dream come true – right? But filing bankruptcy has a dark side. Except in rare instances, it doesn’t discharge debts from mortgages, student loans, taxes, alimony, or child support. Additionally, you can lose certain nonexempt property in a bankruptcy because the court may order it to be sold.

Declaring bankruptcy can also be devastating to your credit score. Granted, your score may already be low if you’re behind on your bills or loan payments. Once you file bankruptcy, the national credit reporting agencies are required to show it on your credit report. A chapter 7 bankruptcy stays on your credit report for 10 years and a chapter 13 shows up for 7 years.

Even if you swear off debt forever, having a bankruptcy on your credit report can hurt more than just your ability to qualify for a future loan or credit card. A company or individual who evaluates potential customers, tenants, or employees by reviewing their credit can use your bankruptcy against you. For instance, they can raise your insurance rates, increase your security deposits, deny your rental application, or turn you down for a good job.

5 Bankruptcy Myths 

Having a bankruptcy on your credit report can hurt more than just your ability to qualify for a future loan or credit card.

It’s important to separate fact from fiction when it comes to owing debt and filing bankruptcy. Here are 5 common myths that are decidedly false:

Myth #1: You Can Declare Bankruptcy by Saying It in Public

In an episode of The Office, when Michael Scott’s finances are tight, he screams, “I declare bankruptcy!” His accountant Oscar says, “Hey, I just want you to know that you can’t just say the word bankruptcy and expect anything to happen.” Michael replies, “I didn’t say it, I declared it.”

Of course, Oscar is right. Filing for bankruptcy typically requires paying a fee, completing credit counseling, and submitting a bunch of legal paperwork and financial disclosures.

Myth #2: You Can Only File Bankruptcy Once

You can definitely file bankruptcy more than once in your life. In fact:

  • You can receive a discharge from a chapter 7 bankruptcy (the kind that liquidates your assets) once every 8 years
  • You can receive a discharge from a chapter 13 bankruptcy (the kind that creates a payment plan) every 2 years

Additionally, if you complete a chapter 7, you must wait 6 years before getting a chapter 13 discharge. And if you get a chapter 13, you must wait 4 years to obtain a chapter 7 discharge. 

Myth #3: A Bankruptcy Hurts Your Spouse

If you’re married, filing bankruptcy doesn’t affect your spouse’s credit. However, if you’re struggling to pay debt that’s in both of your names, then you should file bankruptcy together. Otherwise, creditors will simply demand payment for the entire amount from the non-filing spouse.

Myth #4: You Can Go to Jail for Owing Money

No matter what anyone says—especially an aggressive debt collector—it’s not against the law to owe money. There is no such thing as debtor’s prison in the United States. 

Creditors can sue you, take you to court, lien your property, and garnish your wages, but they can’t send you to jail. You can only be arrested if you commit a crime, like fraud, hiding property to avoid a judgment, or refusing to pay income tax.

Myth #5: Bankruptcy is Expensive

The filing fees for chapter 7 and 13 bankruptcies vary, but aren’t more than $300. The real expense is hiring an attorney, which could range from $2,000 to $4,000, depending on the firm and the type of bankruptcy you choose. You can file bankruptcy without counsel, but I don’t recommend it because the laws are complicated.

While this sounds pricy, in some cases you could rack up much higher expenses in interest and penalties on debt that you have no ability to pay. In the long run, that could be more harmful to your financial future than declaring bankruptcy.

When To File Bankruptcy 

If you can reduce your debts or work out a favorable payment plan with creditors, that’s always a much better option than filing bankruptcy. First, you should explore alternatives such as credit counseling, financial coaching, negotiating with creditors, credit card consolidation, loan modification, and loan refinancing.

Consider bankruptcy when you can’t meet your financial obligations because:

  • You’ve been out of work for an extended period and have no unemployment income or savings.
  • You have delinquent taxes.
  • You have a home that’s nearing foreclosure.
  • You have wages that are being garnished.
  • You have pending lawsuits for delinquent bills.

Everyone’s situation is different, so be sure to seek professional help to carefully evaluate your options when you’re dealing with serious, long-term financial problems. 

More Resources

Follow my advice in Money Girl’s Smart Moves to Grow Rich and you won’t have to worry about bankruptcy ever again!

The Office – “I Declare Bankruptcy!” Video

Bankruptcy image from Shutterstock

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