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Don't Be Afraid of Bankruptcy

Nobody likes to talk about personal bankruptcy. It's the atomic bomb of personal finance: We all know it's out there, but it's really scary, and most of us hope it never affects our lives in any way.

But as we all know, stuff happens. Whether it's a difficult divorce, huge medical bills, an extended period of unemployment, or a wrongheaded investment, financial reversals can hit just about anyone. In fact, although bankruptcy's reputation is as a refuge for deadbeats, most of those who end up filing are regular folks who have gone through a life-changing (and finances-changing) experience like the ones I just mentioned.

And like everything else, bankruptcy gets less scary when you understand how it works and what to expect. If there should come a time when you're swamped with debts and falling further behind every month, it's worth knowing that bankruptcy isn't the end of the world. Of course, there are some major downsides, and it's worth knowing the truth about those as well.

The basics
As you probably know, personal bankruptcy is a process in which a person with debts applies to a special court for protection from creditors while the person's finances are reworked. While your case is in court -- generally a period of several months -- the court has control of your financial problems. Creditors can't foreclose on your house, repossess your car, garnish your wages, or take other action against you while you're under the protection of the bankruptcy court. Instead, a court-appointed person called a bankruptcy trustee works with your creditors to see that they get paid as much as possible.

Whether your debts get wiped out or repaid over time depends on which flavor of bankruptcy you declare. Chapter 13, or "reorganization bankruptcy," involves working with a court-appointed trustee to create a plan to pay back what you owe, usually over three to five years. The plan is often quite strict, and you won't have a whole lot of discretionary income for a while, but when you're done, you're done -- and with some exceptions, your debts will be gone, whether or not you paid them back in full.

Chapter 7, in which most of your debts are just wiped out, is what most people think of when they think of "bankruptcy." Under Chapter 7, the court reviews your debts and your assets and (theoretically) sells off much of the latter to satisfy the former. In practice, people generally end up keeping most or all of their property -- your house, your car (in most cases), and most of your "personal effects" are exempt from liquidation. Although this may sound like a better deal than three to five years of paying back your creditors, recent changes in the bankruptcy laws mean that many filers can't use Chapter 7.

The big myths
Many of the "atomic bomb" aspects of personal bankruptcy turn out to be myths, or at least overblown. For instance, although a bankruptcy is about the worst black mark you can have on your credit record (and it stays there for 10 years), you will get credit again. In fact, you'll start getting credit card offers pretty quickly, though they'll be high-interest subprime offers at first. Still, if you really need a car loan, say, you'll be able to get one -- just at a high rate.

Another big myth is that "everyone will know" because it's a public proceeding. Don't sweat it. Unless you're famous, it'll probably never appear in your local paper -- not all bankruptcy proceedings require published notice, and there are just too many bankruptcy proceedings for any newspaper to run them all. Unless you bought a garage full of expensive luxury cars right before filing and have to forfeit them, or unless you live in a slow-news area and one of your neighbors is a stickler for reading the fine-print legal notices, odds are the neighbors won't ever find out -- or notice anything different at all.

Before you file
If you're considering bankruptcy, start with these steps:

  • Gather complete information documenting your income, your assets, and all of your debts. Get a copy of your credit report to make sure you don't miss any. Put all of the relevant paperwork -- statements from all of your creditors, deeds and titles to property and vehicles, pay stubs, copies of tax returns -- into a folder.
  • Find an attorney who specializes in bankruptcy. If you have an attorney you've used before, ask him or her for a referral to a bankruptcy specialist. Unless you have no other option, don't just go with the guy who advertises in the local paper; try to get a word-of-mouth referral if possible.

Your bankruptcy attorney will advise you on the details of the filing process in your state. Before filing, you will be required (by federal law) to meet with a credit counselor, who will review your debts, income, and assets and work with you to see whether there's any realistic way to repay your debts without a bankruptcy filing.

The big conclusion
Bankruptcy is a tool, plain and simple. It's something of a drastic one, with a scary reputation, but if you ever need it, you'll probably be grateful for its existence. The process isn't that complicated, and assuming that you've been sincere and forthcoming, it's not particularly awful. Most importantly, assuming you take the opportunity to really get your financial house in order, you will recover -- and after 10 years, all will be forgotten.

Do you have questions on bankruptcy? Experience to share? Hop on over to the Fool's friendly Credit Cards and Consumer Debt discussion board, open 24 hours a day.

Fool contributor John Rosevear welcomes your questions and comments. The Motley Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 28, 2009, at 8:43 AM, prginww wrote:

    Bankruptcy dose not have the social stigma it once did I know a company that could really help.

  • Report this Comment On October 24, 2013, at 11:39 AM, prginww wrote:

    Can a bankruptcy attorney in Chicago like answer all the questions I'd have about personal debt or similar financial issues? I'd really like to know more about debt consolidation.

  • Report this Comment On April 18, 2014, at 11:35 AM, prginww wrote:

    I'm getting ready to start school this upcoming fall, and I still have no idea what I want to go into. I have been doing some research though, and after looking around for a bit, I think I want to look into maybe becoming a bankruptcy attorney. I still have to look into it more, but after seeing this and, I have a much better of what they do.

  • Report this Comment On July 15, 2014, at 4:02 PM, prginww wrote:

    My husband wants to go to medical school and it has put a lot of stress on us financially. Even though we aren't to the point of bankruptcy yet, it was still comforting to read this article. I always thought of bankruptcy as a terrible thing, but now I can see how it is actually meant to help people through their difficult circumstances. Thanks for sharing!

    Hope Bray |

  • Report this Comment On July 25, 2014, at 11:44 AM, prginww wrote:

    I have an enormous amount of unpaid medical bills, and I think bankruptcy is my only option. I am not too proud of this, but I am excited to start climbing out of debt. I want to file Chapter 7 bankruptcy, but you mentioned that many people no longer qualify. I hope that I am not one of them.

  • Report this Comment On January 14, 2015, at 11:40 PM, prginww wrote:

    I liked when you mentioned to get that it helps to get a verbal recommendation. Whenever I need a service, I try to talk to the people around me and see if they have any suggestions. I also liked when you mentioned that bankruptcy shouldn't be feared, but looked at as an opportunity to get your finances in order. Thanks for the article. <a href='' ></a>

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