How to Know When Bankruptcy Is Your Best Option

Everyone knows bankruptcy is a last resort option for getting out of debt.

Jan 26, 2014 at 2:44PM
Everyone knows bankruptcy is a last resort option for getting out of debt. Its impact on your creditworthiness affects not only the financial aspects of your life, but can interfere with your ability to get a job, insurance, and even an apartment or home. In general, bankruptcy is viewed negatively, and for those in financial jeopardy, there is always the understandable fear of being stigmatized forever.
However, bankruptcy exists for a reason — to help those who truly need debt relief. Not to be taken lightly, applying for bankruptcy is reserved for those who have been so severely hindered by their spending that they have no way of repaying it, and no alternate options.

You've gone to counseling
To even apply for bankruptcy, you are required to get credit counseling from a government-approved organization with an accredited counselor who helps you assess your personal financial situation. You are walked through all your options for debt relief, including bankruptcy, a modified payment/debt management plan, and debt consolidation.

Sessions can be held online, in person or over the phone, and counselors work with you to help you create a budget and a personalized plan for tackling your problems. If they have reviewed your finances and treat bankruptcy as a viable option for you, there is a likelihood that your circumstances are dire enough to merit applying for insolvency.

You've weighed the other options
You've weighed the other options and none of them feel applicable to you. For example, you may be able to lower the cost of your debt by consolidating it through a second mortgage or a home equity line of credit, but this strategy requires you to put up your home as collateral for the loan, meaning you could lose your home. Additionally, consolidation loans such as these come with a cost.

Another option you may have considered is debt settlement, however, many of these programs mandate that you make monthly deposits to a special savings account for 36 months in order for all your debts to be settled, which many individuals often cannot sustain for such a long period of time. Your credit counselor should be able to give you their professional insight as to how well these methods may work for your needs, lifestyle, and payment abilities.

In the end, you may just want to stop accruing late fees and penalties, and want to start fresh. Bankruptcy can help you do that, though it is a legal court procedure that will stay on your credit report for ten years (if you file for Chapter 7).

You're insolvent
If you're insolvent, or unable to pay your debt, your debt liabilities exceed the fair market value of your total assets. Whether your income and financial assets simply won't be enough to get you out of the hole, or you've overspent to the extent that you literally cannot manage to pay off your debt, being insolvent cannot be easily changed, and is a big indicator that bankruptcy may be the most plausible option for you.

You meet the following criteria
Bankruptcy, specifically Chapter 7, is designed to help you entirely eradicate unsecured debts such as credit card and medical bills. Another sign that you're ready to file for bankruptcy is how frustrated you are with aggressive collection calls and notices, which make trying to live a normal life difficult. Additionally, if you don't own that much property, you won't lose as much, as Chapter 7 makes you susceptible to having property seized, though there are exemptions that may possibly allow you to stay within your home. Finally, if you have a low credit score, bankruptcy won't drastically change your score rating, and once your debt is discharged, you can start from scratch and improve your score.

The takeaway
It's important to make the distinction between Chapter 13 and Chapter 7 bankruptcy. Though each are filed in federal bankruptcy court, and both come with hundreds of dollars in filing fees, Chapter 13 is less severe than Chapter 7. Chapter 13 is for people who have a viable income and are eligible to be put on a repayment plan using future income to pay debts off between three to five years, in exchange for keeping their property. The downside is that the budget is strict, but the plus side is that once your payments have been satisfied, you are discharged of your debts.

Chapter 7 is a process that liquidates all non-exempt assets, which are sold by a court-appointed trustee or turned over to your creditors. Exempt assets include automobiles and basic household furnishings. Usually however, one's property is liquidated. Neither bankruptcy eradicated child support, alimony, fines, taxes, and student loan obligation.

If you're in need of financial help and find yourself struggling to get out of debt, the Federal Trade Commission urges you to meet with an approved credit counseling organization to discuss your options and leave with a money management plan.

Approved organizations are required to give free counseling to those who cannot pay, but individuals must ask for a fee waiver before the session begins, or risk being charged a fee, typically of $50. Though applying for bankruptcy can be a difficult process, it can mean the start of a new life, and the pressure of overbearing debts no longer weighing on your shoulders.

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4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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