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Filing for bankruptcy might be worth considering if you're overwhelmed by debt, but it won't necessarily erase everything you owe. And you might need to forfeit property or agree to continue repaying your creditors, depending on the type of protection you qualify for. Because it can have long-lasting negative consequences on your financial and credit health, bankruptcy should generally be used as a last resort for relieving financial trouble.
Read on to learn when filing for bankruptcy might be your best bet, how it can affect your credit, the advantages and disadvantages, and what to consider before making your decision.
When Should You File for Bankruptcy?
If you've exhausted all other options and are still struggling to get your debt under control, filing for bankruptcy can provide financial relief. Here are some signs that it could be your best move.
- You're taking on new debt to pay old debt.
- You're using credit cards to pay for essentials.
- Making your minimum debt payments barely makes a dent in your total balances.
- You've cut your expenses as much as possible, and you still can't pay your bills.
- You're receiving collection calls.
- Your wages have been garnished.
- Your vehicle has been repossessed or your mortgage lender is starting foreclosure proceedings.
- Your driver's license has been suspended for not paying debt you owe.
- Your creditors have filed lawsuits to collect payments.
- The type of debt you owe is dischargeable in bankruptcy proceedings.
Learn more: What Is a Debt Spiral and How Do I Get Out?
How Much Does It Cost to File Bankruptcy?
The costs associated with filing for bankruptcy fall into three main categories, including:
- Credit counseling fees: You must complete a credit counseling course before you can file for bankruptcy and a debtor education course before the court discharges your debt. Both must be completed through an approved agency, and costs typically range from $10 to $50 per course.
- Filing fee: Court filing fees for Chapter 7 bankruptcy total $335, and the fee to file for Chapter 13 bankruptcy is $310, but there may be additional costs, depending on the details of your case.
- Attorney fees: Working with an attorney isn't required, but they can help you navigate the process and prevent costly errors that could invalidate your filing. Average fees range from $1,500 to $2,500 for a Chapter 7 filing and $2,500 to $3,500 for a Chapter 13 filing, but costs vary by location and the complexity of the case. You'll probably need to come up with the money upfront if you're filing Chapter 7, but you might be able to roll attorney fees into your debt repayment plan if you're filing Chapter 13.
How Does Filing for Bankruptcy Affect Your Credit?
Filing for bankruptcy could decrease your credit scores by up to 200 points and negatively affect your credit for years. But the impact it has in the short term depends on where your credit stands when you file.
Your credit scores might drop less than you expect if the bankruptcy filing follows a history of late payments, collection accounts and other derogatory marks. But if you've managed to stay current with most of your payments and don't have other derogatory marks in your credit history, you could see a sizable decrease in your scores.
A Chapter 7 bankruptcy stays on your credit reports for 10 years from the date you file your petition with the court, and Chapter 13 bankruptcy remains on your reports for seven years from the filing date. The impact of a bankruptcy, like other derogatory marks, decreases over time. But you may receive higher interest rates and less favorable terms while it's on your credit reports.
Pros and Cons of Bankruptcy
To make an informed decision about whether filing for bankruptcy is the right move, it's important to weigh the upsides against the downsides.
Pros
It can erase certain types of debt. Filing for bankruptcy can discharge many of your debts. But it won't necessarily erase all of them. If you want to keep your home or car, you'll need to continue making payments.
You won't have to give up everything. While you may need to sell some of your assets to repay creditors, you get to keep a certain amount of exempt property when you file for bankruptcy. If you file Chapter 13, you might get to keep nonexempt property as well.
Collections stop. When you file for bankruptcy, most collection calls, wage garnishment efforts, and foreclosure, repossession and eviction proceedings stop.
Cons
You may have to forfeit property. If you own property that exceeds your state's exemption limits, you might not be able to keep it.
Your credit will take a hit. It can be difficult to qualify for a loan or credit card with a bankruptcy on your credit reports.
You might still owe. Filing for bankruptcy can provide financial relief, but it doesn't get rid of all types of debt. If you have debt that doesn't qualify for discharge, such as child support or alimony, you'll still have to pay it after the bankruptcy proceeding is complete. If you file Chapter 13, you have to make payments to your creditors for three to five years, depending on your repayment plan—though your payments should become more manageable than they are now.
You have to wait to get a mortgage. Lenders generally won't approve you for a mortgage unless it's been at least one to four years since your bankruptcy petition was filed, depending on the type of bankruptcy you filed and the type of mortgage you want.
What to Consider Before Filing for Bankruptcy
Bankruptcy consequences can be severe. Here are some questions that can help you think through whether it's your best bet for tackling debt and how to proceed if you decide it's the right move.
Is Bankruptcy Your Best Option?
Without considering all your options, there's no way to know if bankruptcy is the right choice. Before filing, evaluate other ways you might be able to get the financial relief you need, including debt consolidation, credit counseling and negotiating with your creditors. Consider the pros and cons of each strategy, including how it could affect your financial and credit health.
Do Your Debts Qualify for Bankruptcy Protection?
Bankruptcy is often touted as a fresh financial start because it discharges many forms of debt, such as credit card balances, unpaid medical bills, personal loans and more. But you could still owe money after the proceedings if you have debt that's excluded from bankruptcy protection, such as:
- Alimony and child support payments
- Criminal fines and restitution
- Court fines and penalties
- Certain unpaid taxes
- Most student loan debt
What Assets Should You Try to Protect?
Because you might not be able to hold on to everything, prioritize assets that are most important to you and allow you to earn a living. If you're still making payments on a mortgage or auto loan, bankruptcy may temporarily prevent foreclosure or repossession. But if you want to keep your home or car, you need to reaffirm the debt in a Chapter 7 filing and make payments as agreed after the discharge. In a Chapter 13 filing, payments must be included in your repayment plan.
Which Type of Bankruptcy Is Most Appropriate for You?
Individuals can typically choose between Chapter 7 and Chapter 13, but the best option depends on your income, assets and type of debt you owe.
Chapter 7 is generally best for people with a low income, few assets and dischargeable debt. Chapter 13 might be a better option if you have a steady income and assets you don't want to forfeit.
- Chapter 7: In a Chapter 7 filing, a court-appointed trustee liquidates your nonexempt assets and uses the proceeds to repay your creditors. Afterward, any remaining dischargeable debt is erased. You get to keep exempt assets up to your state's limit, but to qualify for Chapter 7, your income must be below the state median or you'll have to pass a means test.
- Chapter 13: The court reorganizes your debt, creating a payment plan that lasts three to five years. If you make your payments, remaining eligible debt is discharged when the plan ends. Chapter 13 bankruptcy lets you catch up on past-due auto loan and mortgage payments, and you might even be able to retain nonexempt assets if you repay your unsecured debts.
Alternatives to Bankruptcy
If you're struggling to repay debt, bankruptcy isn't your only option. Here are some alternatives to consider.
Debt Consolidation
Using a relatively low-interest debt consolidation loan to pay off multiple high-interest debts is a time-tested strategy for reducing the amount you owe. It's best used at the first sign of financial trouble while your credit is still in good shape. If your credit's been damaged by missed payments or other missteps, you may not qualify for a loan. And if you do, your interest rate might be too high to make it worthwhile.
Nonprofit Credit Counseling
A nonprofit credit counselor can review your income, debts and expenses and advise you on repayment options other than bankruptcy. They might also arrange a debt management plan (DMP) with your creditors. When you agree to a debt management plan, you repay everything you owe, usually over three to five years. Your credit counselor typically negotiates a reduced interest rate and fee waivers to make payments more affordable.
Creditor Negotiations
You could try working with your creditors directly to reduce your interest rate or extend your loan term to reduce your monthly payments. If your debt problems are temporary, your lender may agree to forbearance or a hardship program, which can reduce your payments temporarily while you get back on your feet.
Debt Settlement
Working with a debt settlement company to settle for less than you owe is also an option, but creditors may not agree to it. These companies usually tell you to stop making your monthly payments and put the money in an account they set up for you instead. When you've set aside enough, they try to negotiate with your creditors to accept a partial payment to settle your debt.
It may sound OK at first, especially if it stops the collection calls, but debt settlement companies charge high fees. If you stop making payments as they recommend, your credit can take a nosedive, and there's no guarantee your creditors will agree to the company's proposed settlement amount. By the time you find that out, you might be further in debt.
Learn more: Risks of Debt Settlement
The Bottom Line
If you've exhausted all other options and are still drowning in debt, filing for bankruptcy may be your best option. But it's important to understand the consequences before you do.
If you decide to file, keep an eye on your credit reports to make sure the discharge gets reported correctly. Experian offers free credit monitoring, and you can get a free copy of your credit reports once a week from each of the three credit bureaus (Experian, TransUnion, Equifax) at AnnualCreditReport.com.
