Bankruptcy is a legal process that can give you a clean financial slate and by going through bankruptcy, many if not most consumer debts can be forgiven. However, filing for bankruptcy is a very serious decision with serious financial and even emotional consequences. For starters, a bankruptcy will remain on your credit report for up to 10 years and can make it difficult to get future credit at non-loan-shark rates, if at all. As a general rule, you should file for bankruptcy only if:
- You’re in a true financial emergency, and
- None of the other available debt management methods will work for you, and
- Your creditors are unwilling to work with you
Otherwise, it would be better to avoid bankruptcy, tough it out, learn to make extra money, and claw your way out of debt. Bankruptcy offers the allure of a quick fix but it can bite you big time down the road.
Bankruptcy is a gut-wrenching, life-changing event that causes lifelong damage. –Dave Ramsey
What is Bankruptcy?
Bankruptcy is a legal process that gives debtors relief from debts they cannot pay and, in some cases, compensates creditors for the money that debtors owe them. Originally, bankruptcy laws were enacted to protect creditors but over the centuries these laws have evolved to protect debtors to a greater extent.
Technically, a person or business is “bankrupt” when the value of their liabilities exceeds the value of their assets. In short, when you owe more than you own, you could be considered bankrupt though most would agree that an individual or business is bankrupt when they can no longer pay their debts for an extended period of time.
When a debtor realizes that he or she can not longer pay their debts, the debtor may decide to initiate a bankruptcy. There are cases when a creditor or group of creditors can “force” an individual or business into bankruptcy to secure their collateral, but most people agree that “forced” bankruptcies are rarely in anyone’s best interest.
The “New” Bankruptcy Laws
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCA) overhauled the U.S. Bankruptcy Code. Some lawmakers believed that individuals were abusing the bankruptcy system by repetitively filing. The new bankruptcy process requires you to:
- Provide more detailed financial and background information than the previous bankruptcy process.
- Take a means test to determine which type of bankruptcy you’re qualified to file (either Chapter 7 or 13 both of which will be discussed in future articles).
Should you file for bankruptcy?
I cannot answer that question for you. Only you and a competent bankruptcy attorney can answer that question together as you both examine your assets, liabilities, and future earning power, but filing for bankruptcy does have its pros and cons.
Pros of filing for bankruptcy
- Eliminates debt: Discharge relieves you from certain types of debts permanently and irrevocably (but rarely for taxes or student loans).
- Your phone will stop ringing: Creditors can no longer contact you to seek collection of your debts.
- Stops those pesky wage garnishments: Once you file for bankruptcy, your wages and savings cannot be garnished, or redirected to creditors or any other third-parties, without your consent.
- Prevents foreclosure and repossession: Any assets for which you have secured loans—such as homes, cars, or boats—cannot be repossessed or foreclosed on by the lender during bankruptcy.
- Prevents evictions: In most cases, landlords can’t evict you while you’re going through bankruptcy.
- Secures your driver’s license: During bankruptcy, your license cannot be suspended for unpaid fines or legal judgments related to traffic or moving violations.
- Secures your job: It’s illegal for employers to fire you because you filed for bankruptcy. They can still fire you for other reasons, such as the quality of your work so get back to it!
- Protects certain assets: When you file for bankruptcy, certain types of assets are protected and can’t be seized and liquidated to pay your creditors. The types of assets protected by filing for bankruptcy vary by state.
- Prevents lawsuits: Filing for bankruptcy puts a temporary stop to nearly every type of civil lawsuit that could be, or has been, filed against you.
- Cancels judgments: Damages you’ve been ordered to pay as a result of a civil lawsuit may be discharged.
Cons of filing for bankruptcy
- Emotional distress: Many people who have been through bankruptcy report that is an emotional rollercoaster. You feel relief and guilt at the same time.
- Kiss the bass boat bye-bye: Not all your assets are protected when you file for bankruptcy. You may be forced to surrender some assets to the court to pay off creditors.
- It isn’t cheap: Court costs and legal fees can easily add up to thousands of dollars, which most people filing for bankruptcy don’t have. Fee waivers are available for certain court costs, but only for filers whose annual income is less than 150% of the current poverty level.
- Public disclosure: Bankruptcy filings become a matter of public record that anyone can access.
- Social stigma: Other people, including those you work for, work with, are related to, or otherwise are acquainted with, may look down at you.
- Future credit problems: A bankruptcy filing can lower your credit score by 100 points or more. Bankruptcies remain listed on your credit report for up to 10 years and can make it difficult to obtain mortgages and other loans, and even more difficult to obtain loans at decent interest rates.
- The court is all up in your business: If you file Chapter 13, you must comply with a court-enforced payment plan (budget) for 3–5 years. During this period, the court remains closely involved in your personal and business affairs.
- Court attendance: You must attend at least one court hearing after filing, which usually requires missing a half-day or more of work.
- Mandatory credit counseling: You’re required to pay for and attend at least two credit counseling sessions in order to qualify for bankruptcy protection. The best bet is to do this BEFORE you file.
- Time: The bankruptcy process takes at least a few months to complete and can be a time-consuming process. Often requires taking a couple of days off from work.
These listed pros and cons may or may not apply to you because of your state’s laws or because of the type of bankruptcy you file, so please check with a competent bankruptcy lawyer FIRST.
Making the decision to file for bankruptcy is a VERY SERIOUS decision, one that should not be made lightly. It WILL affect you and your family for years and years. Make certain you have absolutely exhausted every potential avenue for help including financial counseling, credit counseling, and selling your “stuff” for cash to pay those creditors. Bankruptcy will be more painful than doing without those things!
Note: I am not a lawyer and the information I gathered here came from www.uscourts.gov. The information contained in this article should NOT be substituted for sound legal opinion, nor cited or relied upon as legal advice.