Dollars & Sense: What Happens When You File for Bankruptcy?
By Ben Luthi
Ben Luthi has been a freelance writer since 2013, covering all things money and travel. His work has appeared in many major publications and financial websites, including U.S. News & World Report, The New York Times, Fox Business, Experian, FICO and more. Ben lives in Utah with his two kids, and loves spending his free time traveling, hiking and talking about credit cards.
Bankruptcy can provide an opportunity to get a fresh start with your finances. But the process can be grueling, not to mention damaging to your credit. As a result, bankruptcy is often considered only as a last resort after you’ve tried other solutions to your debt woes.
When you file for bankruptcy, it’s important to know what to expect and how to choose the right type of bankruptcy for your situation.
What Is Bankruptcy?
Bankruptcy is a legal process that you can enter into if you’re unable to pay your debts. During the proceeding, the court will consider your situation and determine how to settle your debts partially or completely.
There are two types of bankruptcy for individuals: Chapter 7 and Chapter 13.
Chapter 7 Bankruptcy
This type of bankruptcy is sometimes referred to as liquidation bankruptcy. It’s designed for low-income borrowers who may not have the capacity to repay on a restructured payment plan.
With Chapter 7 bankruptcy, the court will use a trustee to sell certain assets that you own to pay off at least some of what you owe to your creditors. You won’t be left entirely without assets, though. There are exemptions to protect you.
The Chapter 7 bankruptcy process typically takes three to five months to complete, and when it’s over, you’ll no longer be required to pay the debts included in your filing. Keep in mind, though, that you’ll need to pass a means test to prove your financial need and qualify for this type of bankruptcy.
Chapter 13 Bankruptcy
Also called reorganization bankruptcy, Chapter 13 doesn’t wipe your slate clean, at least not immediately. Instead of requiring you to sell your property, this form of bankruptcy puts you on a court-mandated repayment plan. These plans typically last three to five years, and payments will be based on your ability to pay.
Once you’ve completed the repayment plan, you’ll be able to move on. Also, if you manage to get caught up on secured debts during the process, such as a mortgage or auto loan, you may be able to keep them after the bankruptcy is discharged.
How to File Bankruptcy
The process can be overwhelming, though, so it’s best to hire a bankruptcy attorney to help you with it. They can not only help you file but also advise you on which type of bankruptcy to request.
The cost of hiring a bankruptcy attorney can vary depending on where you live. But for Chapter 7, they can range from $500 to $3,500, and Chapter 13 can cost between $2,500 and $6,000. The difference is that Chapter 7 attorney fees are typically due before you file, while Chapter 13 fees can be paid throughout the reorganized repayment process.
Before you actually file, you’ll need to go through a session with a credit counselor who can review your situation, offer advice on whether bankruptcy is right for you, and potentially provide some alternatives.
What Happens After You File?
Once you’ve submitted your petition for bankruptcy, a court-appointed trustee will arrange a meeting of your creditors, where they can ask questions about your financial situation and plans to repay the debt if applicable.
Then the case will go to a bankruptcy judge, who will decide how to proceed based on the information you provided to the court. It’s crucial to be truthful about your situation and assets to avoid legal ramifications.
If the judge decides in your favor, your request for liquidation or reorganization will be approved, and your debts will be discharged according to the plan. In the meantime, you’ll also need to complete a debtor education course, where you’ll learn about money management.
Once the court has discharged your debt, your creditors are no longer allowed to attempt to collect.
How Bankruptcy Affects Your Credit
Filing for bankruptcy may seem like an easy way out, but the process can be challenging, and the impact on your credit can make it really difficult to get approved for financing in the future.
The most important factor in calculating your credit score is your payment history, and because bankruptcy signifies that you didn’t pay those debts as originally agreed, it can wreak havoc on your credit score.
Even after the bankruptcy is discharged, your options may be significantly limited to loans and credit cards that charge very high interest rates. Over time, though, if you practice good credit habits, the new positive information added to your credit reports can outweigh the negative from your bankruptcy. But this process can take years, so it’s critical that you carefully consider all of your options before you proceed.
Alternatives to Bankruptcy
Before you submit a bankruptcy petition, research some alternatives that can help you solve your debt problem without ruining your credit. Here are some examples:
- Speak to your lender: In some cases, lenders may be willing to work with you without involving the court system. For example, you may be able to get a forbearance on your monthly payments for a time, or they may agree to a modification of the loan terms, which can reduce your interest rate or change some other aspect that makes it easier to pay what you owe.
- Debt consolidation: If your credit score is still in relatively good shape, you may be able to get a personal loan or balance transfer credit card to pay off high-interest credit card debt. These products can offer lower or even 0% interest rates for a time, which can save you money and help you pay down your debt faster.
- Debt management plan: In addition to providing general money management advice, credit counselors can also help you pay down debt through a debt management plan. These plans last three to five years and involve you making one monthly payment to the credit counseling agency, which it disburses to your creditors. They may also be able to negotiate lower interest rates or monthly payments. There is a fee involved with this option, but it’s relatively modest.
- Offer in compromise: If you owe money to the IRS, you may be able to settle with the agency for less than what you owe. The IRS also offers monthly payments if you don’t qualify for an offer in compromise.
- Debt settlement: If you’re behind on payments but want to avoid bankruptcy, debt settlement may be an option. This process involves you (or an attorney or debt settlement company on your behalf) negotiating with your creditors to pay less than what you owe. Settlement can damage your credit significantly, but it’s typically not as bad as bankruptcy.
Depending on your situation, you may be able to take advantage of more than one of these alternatives. Again, it’s crucial that you take your time to consider each one before you decide to move forward.
The Bottom Line
While you may eventually be able to recover from bankruptcy, it’s important to pursue it only when absolutely necessary. Understanding the process and consequences of bankruptcy, as well as some alternatives, can give you the information you need to make the best choice for you and your situation.
Remember that it’s often a good idea to consult with a credit counselor or bankruptcy attorney beforehand to get some expert advice on the matter. And if you’re planning to go through with it, start making plans now to get back on the right track after your debts are discharged.
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Information contained in this blog is for educational and informational purposes only. Nothing contained in this blog should be construed as legal or tax advice. An attorney or tax advisor should be consulted for advice on specific issues.