Making the decision to declare bankruptcy is one that is never easy, nor should it be something that anyone takes lightly. There are times when this financial option is the only choice available because of sudden and overwhelming debt. If your assets do not exceed your liabilities, then you may want to speak with a credit counselor, a bankruptcy attorney, and other professionals in this area to help you to see what options are available in your unique situation.
Many people decide to declare a bankruptcy too late instead of too soon. They desperately try to avoid this circumstance because of the many negatives which are associated with this court filing. Although it should never be a rash decision, claiming bankruptcy before you reach the end of your financial rope could help you to stay in your home, keep your vehicle, and hold onto the personal belongings which are so important to your family.
There are three common bankruptcies in the United States.
- Chapter 7 is an option for individuals who can pass an income tax and have high levels of unsecured debt.
- Chapter 11 is a business option that allows for debt restructuring.
- Chapter 13 is a personal option which helps you to reorganize your debt so that it is easier to manage.
List of the Pros of Claiming Bankruptcy
1. It can discharge many of your debts.
Bankruptcy is an option to consider when your debts exceed your assets and there is no way to recover from that circumstance in the near future. Depending on what your exact financial picture is right now, you may have the option with a Chapter 7 to wipe away a majority of your unsecured debt responsibilities. It won’t discharge items like your student loans in most situations, but you can clear out credit card or medical debt.
If you do not pass the Chapter 7 test, then a Chapter 13 bankruptcy is still an option. Instead of discharging your debt, you’ll get the chance to reorganize and consolidate them into a single monthly payment that you can manage more effectively.
2. You’ll receive an automatic stay with a bankruptcy.
When you decide to file for a bankruptcy in either chapter, then the court will issue what is called an “automatic stay.” This advantage means that any creditors, the businesses or people to whom you owe money, are unable to make collection attempts on your debt. That means the stressful phone calls and threatening letters go away immediately. If someone contacts you after the stay is issued, then you can actually go after them in some situations for financial compensations.
It is essential to remember that this benefit is temporary. If you file a Chapter 13, then you’ll need to negotiate with your creditors on the new payment solution your finances need.
3. You do not lose all of your property during a bankruptcy.
There are a series of bankruptcy exemptions that exist when you file for a Chapter 7 or Chapter 13 in the United States. These are items that a trustee cannot seize during the filing, which means you can often keep many of your personal belongings, jewelry, clothing, a house, and sometimes even a vehicle.
The federal exemptions in this category are extensive. You can keep over $2,000 in tools for your trade, $1,600 in jewelry, and over $12,000 in household goods. Motor vehicles have $3,775 in equity, and one vehicle per spouse is authorized. Tax exempt retirement accounts are exempt without value with the exception of IRAs at $1.2 million.
4. You can maintain your life after filing for bankruptcy.
Many people feel like claiming bankruptcy is an indication that they are a failure. Pride can even delay this process for some when it should not. This court action will also ensure that you can maintain specific baseline for your life. You will not lose your job because of it, even if someone says that you will, because of discrimination laws that exist in the United States. The courts recognize that you need a house and a vehicle to make money, so you’ll get those resources to ensure a paycheck happens.
If you file for a Chapter 13 bankruptcy, then you’re still fulfilling the debt obligations that you have. You’re simply reorganizing the debt so that it works with your current financial situation.
5. Debt relief happens quickly when claiming bankruptcy.
If you qualify for a Chapter 7 bankruptcy, then you should experience relief from your debt in 3-6 months unless there are unusual circumstances that apply to your case. Although the presence of this adverse action will hurt your credit, so do the missed payments, lawsuits, judgments, defaults, and collection accounts. Your credit score could actually be higher with a bankruptcy than it would be if you’re trying to manage more than 2 collection accounts and other debt issues.
6. You get to keep what you buy after you file in most states.
Although a bankruptcy is an ongoing process, the primary generator is your income when dealing with the amount of relief you experience. Once you complete your filing, most states allow you to keep the wages or salary that you earn and the property that you purchase. This advantage even applies to Chapter 7.
Most people can begin to obtain new lines of credit in 1-3 years after claiming bankruptcy as well. You might even qualify for big-ticket financing, such as a car loan or a mortgage, depending on your overall circumstances.
7. The financial relief from a bankruptcy can be virtually unlimited in some situations.
If you don’t owe any money on the type of “secured” debts that survive a bankruptcy, like a student loan or alimony, then the amount of debt and the number of accounts from which you can find relief is virtually unlimited. Although you’re still obligated to pay on items like your mortgage even after the proceedings are complete, the monthly responsibilities that are dragging on your income can disappear in six months or less in most situations. That is why a majority of the bankruptcy filings in the United States involve medical bills.
List of the Cons of Claiming Bankruptcy
1. Most people will not have all of their debts eliminated by a bankruptcy.
If you file a Chapter 13 bankruptcy, then your debts are being reorganized. You might see a reduction in the levels of responsibility that you have, but you’ll still owe something to most creditors.
When you file a Chapter 7, then your most recent back taxes, most student loans, child support, alimony, and fines owed to any government agencies will still remain your responsibility. If a significant portion of your debt that has you underwater fits into these categories, then this financial option may not provide a lot of support. Only a family court can suspend support obligations, and it is up to the government to manage your student loans.
2. You will lose all of your non-exempt property when filing for bankruptcy.
If you file for a Chapter 7, then you will get to keep all of your exempt property as part of this court action. That does mean you’ll be losing anything that is non-exempt, which can sometimes even mean your house or other real estate. Your financial circumstances could also cause you to forfeit stocks, bonds, vehicles, and cash that you currently have available. You’ll want to speak with a qualified bankruptcy attorney about what assets you can protect in your specific situation to avoid an uncomfortable surprise in your circumstances.
3. Bankruptcies stay on your credit record for a long time.
Once you have a bankruptcy on your credit profile, then it is going to stay there for ten years. Although the effects of this public action will begin to fade over time, especially between years 7-10, this issue can make it a challenge to manage any financial purchase that requires credit. You will find that it can be significantly difficult to obtain a loan during this time. You might find it harder to rent an apartment.
If you do receive an approval for a line of credit after a bankruptcy, then you’ll find that the interest rates will be much higher than they would be if you hadn’t needed to file for a Chapter 7 or a Chapter 13 to manage your debt.
4. It isn’t cheap to file for bankruptcy through an attorney.
Although it is possible to file for a bankruptcy without representation, having a qualified professional handle the paperwork and court correspondence can ensure that your rights are fully protected at every step of the process. That means you’ll be dealing with trustee fees, filing costs, credit counseling charges, and the amount that you agree to pay your lawyer. It is not unusual for the total cost of a bankruptcy, even a Chapter 7, to be several thousand dollars by the time you get through the process. That might be money that you don’t have right now.
5. Bankruptcies are an ongoing process.
For most individuals, claiming bankruptcy is not a one-step process that is over and done. Once the court approves this action, then there are certain tasks demanded of each person. That means you might find your relief eliminated if you inherit some money, win the lottery, or receive a promotion at work. Some forms can require you to make monthly payments on the debts you have, and failing to do so can cause additional financial problems that can be tough to get out from underneath.
Although financial management after a bankruptcy is typically easier than trying to juggle numerous debts that are spiraling out of control, you will need to embrace a lifestyle change to ensure that you can avoid this issue in the future.
6. Not everyone will qualify for a Chapter 7 bankruptcy.
If you have a lot of unsecured debt, then a Chapter 7 bankruptcy might make sense. You’ll need to pass the means test before the court will determine if this filing option is valid for your circumstances. You’ll need to have a monthly income amount that is equal to or less than the median income in your state to qualify.
Even if you pass the means test, you might not qualify for a Chapter 7. You’ll need to attend a creditor meeting to answer questions about your financial situation, property, and debts under oath. Some people find that they can pass this test in a couple months even if they fail it today.
7. It is almost impossible to get a new mortgage with a bankruptcy.
If you don’t already have a mortgage and you need to file for a bankruptcy, then expect to be renting for the next 10 years of your life. The presence of this adverse action isn’t a 100% guarantee that you’ll be denied, but it is a virtual certainty – especially in the first 3 years after you proceed with the filing. This disadvantage also means that you might not be able to refinance your mortgage to a better rate if interest rates decline.
If you’re struggling with your mortgage payment after a bankruptcy, then your only available option might be to sell.
8. You are only given a specific number of bankruptcies that you can file.
If you qualify to file for a Chapter 7 bankruptcy because of your financial position, then you’re not given another option under that chapter for another six years. If you find that your assets are still less than your obligations and you can’t pay your bills 3 years after you file a Chapter 7, then the courts will force you to file for a Chapter 13 instead.
You can always pursue a Chapter 13 bankruptcy without limitation. Every separate filing for one will appear on your credit record, which means the 10-year clock starts over every time you need to access this resource.
9. The court can convert your Chapter 7 to a Chapter 13.
If you decide to file for Chapter 7 relief, the amount of disposable income you have can matter to the proceedings. Even if you pass the means test, having extra spending money could cause the court to convert your filing to a Chapter 13. Should that circumstance occur, you’ll be required to create a plan with your creditors that will have you repaying your debts in 3-5 years instead of being free from them in six months or less. You don’t get a say in that process either, so it can be an unexpected and unpleasant surprise.
This disadvantage is another reason why it is usually better to work with a qualified bankruptcy attorney if you need a Chapter 7 instead of trying to do all of the work on your own.
10. You are going to lose all of your credit cards.
Whether you file for a Chapter 7 bankruptcy or a Chapter 13, this process will take away your current credit cards. You might be able to obtain new ones in a few years, but you’ll lose the credit advantages of having a history. That also means any rewards you have will disappear. People who operate a business and find themselves filing for a Chapter 11 can encounter this disadvantage as well.
Because credit card debt can be a significant factor in the need for a bankruptcy, some households may not see this issue as a disadvantage. If you have a lot of open space on your credit profile and your goal is to manage your medical debt better, you might find that a payment agreement with your creditor that makes use of this asset could put you into a better financial situation.
11. You’ll need to justify your position.
When you file for a bankruptcy, then you will need to explain to a judge, trustee, or both how you got into this situation in the first place. Although most have heard stories that are far worse than yours, it can be highly embarrassing to recount your poor decisions from the past that led you toward debt. Justifying your position can make or break some cases as well, so you’ll want to be honest about what happened and what you hope to accomplish in the future.
Verdict on the Pros and Cons of Claiming Bankruptcy
Claiming bankruptcy can feel like failure. It is evidence that your debts got out of control and you couldn’t do anything about the situation. Some people feel like they are better off letting their debts pile up, especially if they can pay a portion of their obligations each month. That’s why experts in this field say that so many people file later than they should be – it becomes a situation of last resort.
If the court approves your bankruptcy, then a Chapter 7 can wipe away many of your debts. A Chapter 11 or Chapter 13 will help you to reorganize your wealth so that it becomes easier to manage your obligations. All of these options can help get you toward a healthier financial future, but only if you’re willing to make some changes.
The pros and cons of claiming bankruptcy require you to avoid the pitfalls that got you into that situation in the first place. They can also help people deal with emergencies or financial problems that are unusual to create recovery options. If you’re struggling with debt right now, then it may be wise to speak with a qualified attorney sooner rather than later.
Blog Post Author Credentials
Louise Gaille is the author of this post. She received her B.A. in Economics from the University of Washington. In addition to being a seasoned writer, Louise has almost a decade of experience in Banking and Finance. If you have any suggestions on how to make this post better, then go here to contact our team.