If you have more debt than you know how to handle, you might be interested in filing for bankruptcy. Bankruptcy could potentially allow you to discharge most or all of your debts, in exchange for taking a massive hit on your personal credit.
But what exactly is the bankruptcy process like? And is this the right move for you?
How Bankruptcy Works
If you’re interested in filing for bankruptcy, you’ll typically follow a process like this:
- Meet with a lawyer. Bankruptcy is a complex legal process, and not one the average person can successfully navigate alone. While it’s technically possible to file for bankruptcy independently, you’re much better off working with a bankruptcy lawyer. Your bankruptcy lawyer will help you understand the different types of bankruptcy that are available to you, the overall process, and the potential consequences of your decision. From start to finish, they’ll provide you with expert advice and ongoing guidance.
- File the paperwork. To get the bankruptcy process moving, your lawyer will help you file some initial paperwork.
- Meet with a credit counselor. In most cases, you’ll need to complete a round of credit counseling with a credit counselor approved by the government. During this process, the counselor will assess your finances, help you identify potential bankruptcy alternatives, and help you prepare for your financial future.
- Demonstrate an inability to pay off your debts. During this course, you’ll also need to prove that you’re unable to pay off your debts. You will not be able to declare bankruptcy if there is another financial path forward.
We can’t go into more details about this process, since different types of bankruptcy work differently.
Different Types of Bankruptcy
There are many different types of bankruptcy, but the most relevant ones to average consumers are Chapter 7 and Chapter 13 bankruptcy.
In Chapter 7 bankruptcy, you’ll relinquish ownership of most of your property and positions in exchange for discharging all your debt. A federal court trustee will supervise the liquidation of all nonexempt assets you own, using the proceeds of the sale to pay off any debts you currently owe. After this process is done, any remaining debts are formally discharged. After this, Chapter 7 bankruptcy will remain on your credit report for 10 years.
Chapter 13 bankruptcy works differently, as it allows you to keep your property in exchange for coming up with a repayment plan to pay off your debts. The court will serve as a kind of mediator, working with you and your creditors to negotiate a fair deal. You may end up owing less than what you started with, but you’ll be responsible for paying off the remainder of these debts over the course of 3 to 5 years. When complete, chapter 13 bankruptcy remains on your credit report for 7 years.
Do note that in both Chapter 7 and chapter 13 bankruptcy, certain types of debts are not dischargeable, such as alimony, child support, tax debts, and certain types of student loans.
The Long-Term Effects of Bankruptcy
These are the most important long-term effects of bankruptcy to understand:
- Loss of property. In Chapter 7 bankruptcy, you may be allowed to keep your house, your car, and a few other exempt possessions, but you’ll lose most of your other property.
- Credit impact. Having bankruptcy on your credit report means it’s going to be very difficult to take out a mortgage, open a new credit card, and even find an apartment.
- Impact on others. If you have any cosigners on your account, be aware that your declaration of bankruptcy can affect them as well.
Is Bankruptcy Right for You?
Is bankruptcy the right move for you? It’s tempting to think of bankruptcy as a magic wand that makes all your debt go away, but the consequences are harsh and the process is challenging. Most people are better off pursuing an alternative first, such as:
- Improving your personal finances. Increasing your income, reducing your monthly expenses, and using your leftover money to pay down your debts each month could help you gradually inch closer to freedom from debt.
- Selling your possessions. Selling your possessions could help you raise enough proceeds to pay off some of your biggest debts.
- Negotiating and consolidating. If you negotiate with creditors or consolidate your loans, you can reduce what you will owe and end up in a more favorable financial position.
- Credit counseling. You can also seek credit counseling outside of a court context. Credit counselors will work with you to help you understand your personal finances – and come up with a better financial path forward.
If you’ve tried all the alternatives, bankruptcy may be your best and last option. Talk to a lawyer before you make any final decisions.
