Bankruptcy can provide relief from crippling debt, but it has serious negative consequences. Here are some questions to consider before you file for bankruptcy to help clarify whether it’s the right move for you.

Exhaust Your Other Options First

Because of its serious ramifications, consider bankruptcy only as a last resort. First, explore other bankruptcy alternatives:

Credit Counseling: A certified nonprofit credit counselor can help you sort out your finances, find ways to get debt under control, and offer guidance even if bankruptcy turns out to be your best option. Credit counselors typically charge modest fees, with some offering sliding-scale fees based on your ability to pay.

Debt Consolidation: If your credit remains sound, consolidating high-interest credit card debt with a relatively low-interest personal loan or a balance transfer card can be a smart strategy.

Debt Management Plan (DMP): Credit counselors can help you adopt smart budgets and economizing measures. If that’s not enough, they may intervene with creditors to set up a debt management plan. A DMP allows you to make full or partial repayments to creditors in smaller amounts, typically leading to the cancellation of credit accounts and damage to your credit scores. However, this damage can be less severe than bankruptcy.

Debt Settlement: For-profit debt settlement companies usually have you withhold payments to your creditors, funneling cash into a dedicated bank account to offer partial repayment. This method is expensive and potentially devastating to your credit. Debt settlement often increases customers’ debt levels and could still lead to bankruptcy if creditors don’t accept the terms.

Choose the Right Type of Bankruptcy

Two types of bankruptcy protection are available to individuals in the U.S.:

Chapter 7: Known as liquidation bankruptcy, Chapter 7 requires you to forfeit property and assets valued beyond a state-specific limit. A bankruptcy trustee sells forfeited assets and distributes the proceeds among your creditors.

Chapter 13: Called the wage-earner’s plan, Chapter 13 establishes a repayment plan lasting three to five years. During this time, you make regular monthly payments to a bankruptcy trustee, who then distributes the funds to your creditors.

Eligibility criteria, including a means test, may determine that you only qualify for one type of bankruptcy. In cases where either path is possible, answers to the following questions can help guide your choice.

Check If Your Debt Qualifies for Bankruptcy

Bankruptcy can cancel (or discharge) many types of consumer debt, including credit card balances, personal loans, and unpaid rent and medical bills. However, certain debts cannot be erased, such as:

• Unpaid alimony and child support
• Certain unpaid criminal fines
• Certain student loans
• Unpaid taxes

If most of your debt falls into these categories, a Chapter 13 repayment plan may help you get caught up on delinquent payments, but it cannot eliminate the obligations altogether.

Protect Your Assets

Both Chapter 7 and Chapter 13 allow you to retain some assets, but only Chapter 13 can prevent lenders from seizing collateral on unpaid secured loans such as mortgages or auto loans. If you are behind on car or house payments, a Chapter 13 repayment plan can halt the foreclosure or repossession process, enabling you to get caught up on payments and keep the asset, provided you make future payments on time.

Hire an Attorney

While you can represent yourself in a bankruptcy case, hiring a bankruptcy attorney is highly recommended. A lawyer familiar with bankruptcy procedures can help you avoid missing filing deadlines and prevent other missteps that could impede your case.

In a Chapter 7 case, you must pay your legal fees upfront and in full before the case is finalized.

In a Chapter 13 case, your legal fees can be incorporated into your payment plan

Understand the Consequences of Bankruptcy

Bankruptcy can have negative repercussions that last for years, including loss of assets and significant damage to your credit scores.

Chapter 13 bankruptcy appears on your credit reports for seven years from the month you filed for protection.

Chapter 7 bankruptcy appears on your credit reports for 10 years from the month you file.

Bankruptcy hurts your credit scores as long as it remains on your credit reports. However, the extent of its impact lessens over time, especially if you practice good credit habits after your bankruptcy. While some lenders consider a bankruptcy on your credit report grounds for denying any credit application, others may offer you loans (typically with steep interest rates and fees) within a few years of your filing date.

Take Immediate Steps After Bankruptcy

Begin rebuilding your credit as soon as your bankruptcy is finalized. Some options include:

Get a Secured Credit Card: Placing a cash deposit that serves as your borrowing limit and using the card prudently can help reestablish a pattern of on-time debt payments.

Become an Authorized User: Being an authorized user on a credit card held by a friend or family member with good credit can help your credit scores by letting you share in that card’s positive payment history.

Take Out a Credit-Builder Loan: Borrow a small sum, often $1,000 or less, placed in an interest-bearing savings account. Repay the loan in installments over up to 24 months, generating positive payment activity on your credit reports.

Change Your Habits to Prevent Future Missteps

Bankruptcy can result from unavoidable misfortune, like medical crises or natural disasters. However, it can also stem from mismanagement of personal credit accounts. If your consideration of bankruptcy arose from excessive credit card purchases or unaffordable loan installments, reflect on your choices and vow not to repeat your mistakes. Credit counseling can be a big help with this.

The Bottom Line

Bankruptcy is not a step to be taken lightly. After considering the preceding questions and consulting trusted advisors, if you decide to move ahead with Chapter 7 or Chapter 13, you and your credit can recover. Time will lessen the negative consequences for your credit scores, and within a few years, some lenders may even extend you offers for loans or credit cards.

If you ever need expert assistance or guidance on your credit journey, don’t hesitate to reach out to the Nerds! Additionally, stay updated with the latest tips and information by following us on Facebook, Instagram and TikTok!