Published in: Banks | Oct. 7, 2019

Should I File for Bankruptcy?

Photo of Lyle Daly

By: Lyle Daly

Bankruptcy isn’t a decision to take lightly, but it could be what you need to fix your finances.

If you’ve been considering bankruptcy, odds are that you’ve been going back and forth on whether it’s the right decision. It’s not like there’s a handy table that tells you to "declare bankruptcy when you hit this amount of debt."

There's a long list of factors you need to consider, including your total debt, the types of debt you have, and your income. On top of that, you need to know about the different types of bankruptcy and their long-term ramifications.

In this guide, you’ll learn all about how bankruptcy works and how you can determine if you should use it to discharge your debts.

An upset woman on a couch staring at a laptop.

Image source: Getty Images

Reasons to file for bankruptcy

It’s hard to be sure that declaring bankruptcy is the right decision, but there are several signs that it’s likely your best option.

You’re going further into debt every month. If you’ve used up most of the money in your bank account and you’re adding to your credit card balances just to cover your essential expenses, then you have three options: cut your expenses, increase your income, or file for bankruptcy. Assuming the first two aren’t possible, bankruptcy is the only way to stop digging yourself into a deeper hole.

You’ve missed multiple payments. When you’re behind on your payments by months or you’ve missed payments on multiple debts, your credit score has probably already taken a significant hit. At that point, you need to consider whether you can realistically catch up on your payments.

You could lose your home or car. Facing an eviction from your apartment, a foreclosure on your home, or a repossession of your car? A bankruptcy filing will put an automatic stop to any of those. This is only temporary, so you will still need to work out how to deal with your payments, but bankruptcy will at least buy you some time.

Keep in mind that if you’re behind on your mortgage, Chapter 13 bankruptcy will allow you to catch up through the payment plan you set up. If you file Chapter 7 bankruptcy, the foreclosure process will eventually 678continue unless you can get current on your mortgage. Read on to understand the differences between Chapter 13 and Chapter 7 bankruptcies.

The two types of bankruptcy

Although there are several types of bankruptcy available, the two that are available for all customers are Chapter 7 and Chapter 13.

Chapter 7 bankruptcy

With a Chapter 7 bankruptcy, you liquidate all your non-exempt assets, and the proceeds are used to pay your creditors. Your remaining debts are discharged, with the exception of debts that don’t qualify.

This type of bankruptcy is the quickest option available to discharge your debts, as in most cases it only takes about three to four months. You can hire a bankruptcy lawyer to help you file, but many consumers do it on their own.

Not everyone is eligible for a Chapter 7 bankruptcy. To qualify, you must do one of the following:

  • Demonstrate that your household income is less than the median income in the state where you reside.
  • Pass the means test. For this test, you provide your income and allowable expenses for the last six months. The difference is considered your disposable income, and if it’s low enough, then you can file this type of bankruptcy.

If you don’t qualify for Chapter 7 bankruptcy, then your only option is Chapter 13.

Chapter 13 bankruptcy

Chapter 13 bankruptcy requires you to make a payment plan based on what you can afford to pay every month. Depending on your income, this plan will last between three to five years. After you complete it, any remaining debt will be discharged. It's often referred to as the wage earner's bankruptcy, and it's intended for those who have the income to pay their debts, but can't pay as quickly as their creditors want.

Because you must follow a payment plan for this type of bankruptcy, it’s not the fast solution you get with a Chapter 7. But one benefit is that you won’t need to liquidate any of your property.

You will most likely need a lawyer to file Chapter 13 bankruptcy, because making an acceptable payment plan can be challenging. After you submit your plan to the court, the judge decides whether to approve it or reject it. 

There are requirements you must meet to file Chapter 13 bankruptcy. You must be current on your tax filings, you must have sufficient income to make monthly payments on your debt, and the amount of secured and unsecured debt you have must be below certain limits. As of September 2019, the limits are:

  • Less than $394,725 in unsecured debt
  • Less than $1,184,200 in secured debt

Which debts are not dischargeable in bankruptcy?

There are some debts that you can’t get out of, even by filing bankruptcy. Here are the types of debt that are not dischargeable through either Chapter 7 or Chapter 13 bankruptcy:

  • Alimony
  • Child support
  • Unpaid income taxes, Social Security taxes, withholding taxes, and any other back taxes or tax penalties
  • Debt you owe from breaking the law, including restitution and fines

Certain types of debt are dischargeable through Chapter 13 bankruptcy, but not through Chapter 7, including:

  • Loans you borrowed against a retirement plan
  • Homeowner’s association (HOA) and/or condo fees
  • Court fees
  • Debts from a divorce or settlement agreement

Although there’s a misconception that student loan debt can’t be discharged in bankruptcy, this isn’t entirely true. To discharge your student loans in bankruptcy, you must demonstrate to the court that paying them back will cause you undue hardship. In practice, this is very difficult to prove, but it is possible in select circumstances.

What to do before you consider bankruptcy

Bankruptcy is a last resort that you should only turn to if you have no other realistic way to pay off your debt. If you think you need to declare bankruptcy, make sure you’ve tried all of the following:

Cut your expenses. Your first move, if you haven’t done so already, should be to make a strict budget and eliminate any unnecessary expenses. That includes every expense, even the small ones that don’t seem like a big deal, such as Netflix, Spotify, and eating out.

Next, subtract your necessary expenses from your income to see if you have any disposable income left over. If so, multiply your monthly disposable income by 60 to see how much you could realistically pay towards your debt in the next five years. Since consumers with sufficient income must file Chapter 13 bankruptcy and follow a payment plan for three to five years, it’s worth seeing if you could do this on your own and pay off your debt without filing.

Sell property. If you're planning on filing Chapter 7 bankruptcy, you’d need to liquidate your nonexempt property anyway during bankruptcy proceedings. See whether doing that first could earn you enough to make a dent in your debt. In that case, you could sell some possessions and pay down what you owe.

Consolidate your debt. Consolidating debt, could roll several monthly payments into one -- potentially one which has a lower interest rate. Here are a few of the most common debt consolidation options:

  • A personal loan: You apply for a personal loan, and then use the loan to pay off your debt. You’ll have one fixed payment amount to make over the term of the loan.
  • A balance transfer credit card: With balance transfer cards, you could get a 0% intro APR for well over 12 months, which is a great way to avoid drowning in interest charges. However, many of these cards charge balance transfer fees, and the APR will go up after the card’s intro period ends.
  • A home equity loan or line of credit (HELOC): Consumers with equity in their home can use that equity to get a loan or line of credit, and then use the line of credit to pay their debts. This method can be risky, though, because you’re putting your home up as collateral.

For a personal loan or a balance transfer card, your credit score will need to be good enough to get approved, and the amount you can borrow will be based on your credit and income.

Negotiate with creditors. Your creditors may work with you if you contact them to explain your situation. Many creditors will offer what’s known as a hardship plan, which means they adjust the terms of your debt so that it’s easier for you to pay it. Ways they could do this include:

How much will your credit score drop from a bankruptcy?

Your FICO® Score (the most widely used type of credit score) can drop by as much as 240 points due to bankruptcy. The amount will depend on what your credit score was before the bankruptcy, as higher scores suffer a larger decrease.

FICO has released a report clarifying how much consumers with different credit profiles can expect to see their credit score drop after declaring bankruptcy. Here’s the kind of decrease you can expect if you have good or excellent credit:

Original credit score

Credit score after bankruptcy

Difference

780

540-560

220-240

680

530-550

130-150

Data source: FICO.

Whether you have a poor or an excellent credit score to start, it will probably end up in the mid-500s or lower after bankruptcy.

How long does it take to rebuild credit after a bankruptcy?

The length of time a bankruptcy can legally remain on your credit report is:

  • Ten years from your bankruptcy filing date with Chapter 7 bankruptcy
  • Seven years from your bankruptcy filing date with Chapter 13 bankruptcy

As with any negative mark on your credit report, a bankruptcy will have the biggest impact immediately after it happens. If you follow good financial habits after that, it will gradually affect your score less and less.

To rebuild your credit, you need to have at least one bill that gets reported to the credit agencies every month. If you pay this on time, you can start to build a strong payment history. One way to do this is to get a secured credit card, which is usually all you’d be able to qualify for shortly after a bankruptcy. Use it for at least one small purchase a month and pay the entire bill on or before the due date.

Picking the right time to file

So you’ve decided that bankruptcy is the best move you can make. You should probably get started on filing, right?

Not necessarily. And if you rush this, you could regret it later. When you file for bankruptcy, you want to ensure that you get the most possible financial benefit from it. To do that, there are a couple things you’ll need to think about.

Income. Bankruptcy courts calculate your income using the monthly average over the previous six months. If you’ve recently suffered a drop in your income, then you should wait until six months have passed before filing for bankruptcy. That way, the income the courts calculate for you is as low as possible. On the other hand, if your income has recently increased, then you should file for bankruptcy as soon as possible.

A lower income in your filing could help you qualify for a Chapter 7 bankruptcy or result in lower monthly payments  with a Chapter 13 bankruptcy.

Upcoming expenses. Have any major expenses coming up -- like surgery -- that you can’t avoid? In that case, if you file for bankruptcy after paying them, you'll be able to include them in your bankruptcy.

Let’s say that you need a surgery in two months time that will cost you $10,000 out of pocket. You might as well wait to file your bankruptcy, because including those medical bills in your petition will save you $10,000.

Now, here’s an important disclaimer: This only works with necessary expenses. If you rack up unnecessary expenses right before your bankruptcy, those debts may not be discharged. Don’t think that you can go on a pre-bankruptcy shopping spree, because the court will see right through that.

How to file for bankruptcy

If you thought that filing bankruptcy was a fast process, then you’re in for a surprise. There are several steps involved, and the process will take you a few months. A lawyer can make filing much easier for you, especially if you’ll be declaring Chapter 13 bankruptcy.

When you’re ready to file, here’s what you’ll need to do:

1. Gather your financial documents

You’re going to need all your financial records as you go through the bankruptcy process. This includes verification of your:

  • Income
  • Debts
  • Assets
  • Expenses

It’s best to keep these in folders so that they’re organized and you don’t need to search for them later.

2. Complete a credit counseling course

You must take a credit counseling course in the 180-day period before filing your bankruptcy petition. This is required to ensure that you’ve thoroughly considered every option to resolve your financial situation before deciding on bankruptcy.

The U.S. Department of Justice has an online tool to find approved credit counseling agencies in every state. Most agencies provide courses both online and over the phone.

Courses last an hour or longer, and course fees are generally between $20 and $50. However, if your household income is 150% or less of the Federal Poverty Level Guidelines, you can apply for a fee waiver with the credit counseling agency.

3. Decide which type of bankruptcy you’ll file

At this point, you should have a good idea of which type of bankruptcy you’ll qualify for and which is better for you. Since some of the forms will be different depending on the type of bankruptcy you’re filing, you’ll need to decide that now.

4. Fill out the bankruptcy forms

There are many bankruptcy forms to complete, and you’ll want to be careful as you fill them out, because any error could lead to issues with your petition. To find the forms online, go to the U.S. Court’s bankruptcy forms page.

This is one area when a lawyer can assist you quite a bit, or you can also use a bankruptcy software.

There will be a filing fee of $335 for a Chapter 7 bankruptcy or $310 for a Chapter 13 bankruptcy. This fee is due at the courthouse. If you can’t pay it, then you will need to fill out either a fee waiver form or an installment payment form that you submit with your other bankruptcy forms.

5. Submit your forms

Once your forms are ready, you need to print them out (single-sided, as the court won’t accept forms printed double-sided), sign them, and take them to your local courthouse.

Go to the office of the court’s clerk and give them your bankruptcy forms. When the clerk processes them, you’ll get a case number, the name of your bankruptcy trustee, and information for your required meeting of creditors, also known as a 341 hearing.

Note that if you’re filing Chapter 13 bankruptcy, you must also submit a payment plan within 14 days of filing your bankruptcy forms and begin making payments within 30 days of filing your forms.

6. Complete the debtor education course

There’s one more course that’s required to file for bankruptcy, and that’s the debtor education course. This course focuses on how to make better financial decisions so that you won’t end up with the same problems in the future.

Like the credit counseling course, you can find debtor education agencies through the online tool provided by the U.S. Department of Justice. You can take the course online or by phone, the course fee is also about $20 to $50, and you can apply for a fee waiver if you meet the income requirements.

7. Provide your financial documents to your trustee

Your bankruptcy trustee will get in touch with you by mail and request certain financial documents after you submit your bankruptcy forms. Mail these documents to your trustee as soon as possible to avoid any delays or problems with your filing.

8. Go to your meeting of creditors

The final step is to attend your meeting of creditors, where your trustee will verify your identity and ask you financial questions. Your creditors also have the right to come to this meeting, but this is extremely rare.

Make sure you bring your ID, Social Security card, bankruptcy forms, and financial documents to this meeting. If your trustee has requested any specific documents, bring those as well.

What comes next

After you’ve completed the filing process, the next step will depend on the type of bankruptcy you’ve filed.

Chapter 7 bankruptcy: Within a couple months, you should receive a notification in the mail stating that your debts have been discharged. At this point, you can focus on moving forward with your life and rebuilding your finances.

Chapter 13 bankruptcy: You’ll need to stick to your payment plan for three to five years. Once you’re done with that, your remaining debts will be discharged.

Bankruptcy is a difficult process that has long-term implications on your financial situation, so it's not something to jump into blindly. But if you've evaluated all your options and determined that bankruptcy is your best chance for a fresh start, then you should pick the smartest time to file and go through the entire process correctly. Doing it right will ensure that you only need to go through the process once.

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