Here's What Happens When You File For Bankruptcy

The game is up. The floor has crumbled, the ceiling is falling, and lenders have your ankles grasped tight. You're being pulled into a bottomless debt spiral, and there's no way forward but down, down, down.

You consult your attorney on the matter. Together, you reach a solution: Declare bankruptcy, the legal process that helps individuals reorganize or eliminate debt.

Declaring bankruptcy is a big deal. On one hand, it potentially eliminates or reduces your debt to manageable levels. On the other, it carves through an individual's possessions and credit score like a hot knife through butter. 

If you're an individual filing bankruptcy, rather than an organization, you typically have two options: Chapter 7 and Chapter 13. Here's what happens when you file for bankruptcy.

Chapter 7

Chapter 7 is the Hail Mary of bankruptcies. In a Chapter 7 bankruptcy, you are appointed a trustee that helps you sell your assets to repay your debt. By the end of the process, all your debts are forgiven, with a few notable exceptions. 

If you and your attorney decide it's in your best interest to file a Chapter 7, you'll have to do two things first: pass the means test and take a credit counseling course. The counseling course helps you decide whether bankruptcy is right for you.

The means test determines your ability to actually repay your debts, or lack thereof. Should you pass it, you can file a Chapter 7. Should you fail the means test, you have three options:

• File for Chapter 13.
• Wait six months and try again.
• Decide against filing for bankruptcy in favor of other debt-repayment strategies.

There were 413,616 Chapter 7 bankruptcy filings in 2021, according to a study by The Ascent. Chapter 7 does the most to eliminate debt. But a Chapter 13 bankruptcy gives filers more control over their assets.

Chapter 13

A Chapter 13 bankruptcy is a softer pitch than a Chapter 7. In Chapter 13, you are appointed a trustee. The trustee helps you reorganize and possibly renegotiate debts so they're easier to repay. Most notably, you get to keep your belongings, including your home.

If you and your attorney decide it's in your best interest to file a Chapter 13, you'll have to take a credit counseling course first. Then you can file and begin the process of reorganizing debts so that they're payable within three to five years.

Here's what happens after

There are consequences to filing for bankruptcy, both positive and negative. 

The good:

• Chapter 7 filers will have eliminated most (if not all) of their debts.
• Chapter 13 filers will have reorganized and/or reduced their debts so they're manageable.

In general, the best part of filing for bankruptcy is that debt becomes manageable. Even if debt isn't completely eliminated, there is a clear path to paying it off. In some ways, it's a clean slate.

The bad:

• Filers will see a significant drop to their credit scores.
• Filers may lose a significant amount of assets, including their homes and heirlooms.
• Filers may have their bankruptcy details become publicly searchable.

There's more to bankruptcy than losing your valuables. After you declare bankruptcy, your credit score drops, and borrowing money becomes harder. Taking out a mortgage? That'll cost you. Taking out an auto loan? Buckle up for higher rates.

Bankruptcy can be a drawn-out, painful process with long-lasting repercussions. There are other options, like debt consolidation, which makes debt more manageable. For example, you may wish to take out a debt consolidation loan to shrink credit card interest payments.

The decision to file for bankruptcy is a serious one. Consider consulting with an attorney before filing. You'll benefit from the opinion of an expert sworn to protect your best interests.