Bankruptcy

Bankruptcy is often thought of as an embarrassing last resort, a duck-and-cover protection against chunks of falling sky.

But it’s more helpful to think of bankruptcy as a legal tool to use when you or the business you own cannot repay outstanding debts or obligations.

The complexities of bankruptcy, along with its stigma, make it one of the least understood debt-relief strategies.

What is bankruptcy? Bankruptcy is a proceeding where a judge and court-appointed trustee examine the assets and liabilities of individuals, partnerships and businesses who’ve concluded they can’t pay their debts.

Experts say it should be a last resort to settle your financial woes.

The only sign that you should consider talking to a bankruptcy lawyer is having the feeling that you are financially drowning, It looks and feels different to everyone, and your own tolerance for anxiety and misery will drive the bus.

“The biggest misconception, by far, is that bankruptcy is a BAD thing,” said Adrienne Hines, a bankruptcy and workers comp attorney with Kademenos, Wisehart, Hines, Dolyk and Wright in Sandusky, Ohio.  “Bankruptcy is just one tool in the financial toolbox. Being smart about your options and exploring your choices are more important than being embarrassed or ashamed.”

How Does Bankruptcy Work?

Bankruptcy gives creditors an opportunity for repayment when assets belonging to an individual or business are liquidated.

All bankruptcy cases are filed in federal court. Judges examine the bankruptcy filing to determine a debtor’s eligibility and then decide whether to discharge that debt.

A trustee is appointed to represent the debtor’s estate. Most cases are handled between the judge and trustee and don’t require the debtor to appear in the court proceedings.

A decision can be made to discharge, meaning the debtor is no longer liable to pay those debts. Or the judge could dismiss the filing if he or she believes the individual or business has the means to pay their debts.

“When you file for bankruptcy, you are taking the first step in creating a plan to begin your journey toward a new financial life,” Scott Glatstian, associate attorney with Rosenblum Law, said.

» Learn More: Can Bankruptcy Be Denied?

Filing for bankruptcy can be a saving grace for people drowning in debt. The numbers support that contention. The American Bankruptcy Institute says that 95.3% of people who file Chapter 7 bankruptcy are successful.

Types of Bankruptcy

There are six types of bankruptcy – Chapter 7, 9, 11, 12, 13 and 15.

Chapter 7 and 13 accounted for 98.2% of bankruptcy filings in 2023:

• Chapter 7: A court appointed trustee may sell your assets and distribute the net proceeds to creditors if you have assets not protected by an exemption.
• Chapter 9: This proceeding provides financially distressed municipalities – cities, townships, school districts, etc. – with protection. It creates a plan to resolve the debt between the municipality and its creditors.
• Chapter 11: Otherwise known as “reorganization bankruptcy,” Chapter 11 involves a restructuring of a debtor’s business affairs, debts, and assets. Companies use Chapter 11 to restructure debt while remaining open for business.
• Chapter 12: This is designed for financially distressed “family farmers” and “family fisherman.” The person in debt devises a plan to pay back creditors over 3-5 years.
• Chapter 13: Chapter 13 enables individuals with regular paychecks to restructure debt and repay some or all creditors. For that reason, it’s often referred to as “wage-earner’s bankruptcy.”
• Chapter 15: Added to the code in 2005, Chapter 15 bankruptcy provides for cooperation between U.S. courts and foreign courts in the event foreign bankruptcy filings affect financial interests in the U.S.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy is generally the best (and most commonly used) option for those with a low income and few assets. In 2023, Chapter 7 bankruptcy filings rose 15.8% from 225,455 to 261,277 over the previous year.

A successful Chapter 7 bankruptcy can erase unsecured debts. You also could be permitted to keep key assets considered “exempt” property. Non-exempt property will be sold to repay part of your debt. Just know that property exemptions vary state-to-state.

By the end of a successful Chapter 7 filing, the majority (or all) of your debts will be discharged, meaning you won’t have to repay them. Some debts that won’t be discharged in bankruptcy include alimony, child support, some types of unpaid taxes and most types of student loans.

Chapter 7 bankruptcy stays on your credit report for 10 years, but your score could improve over time as you rebuild your finances.  While some individuals may not qualify due to high income, others simply can’t afford Chapter 7 bankruptcy due to the fees and expenses.

Chapter 13 Bankruptcy

Chapter 13 bankruptcies make up about 42.3% of non-business bankruptcy filings. There were 183,956 Chapter 13 filings in 2023, an increase of 26,869 from 2022.

A Chapter 13 bankruptcy involves repaying some debts in order to have the rest forgiven. This is an option for people who do not want to give up their property or do not qualify for Chapter 7 because their income is too high.

People can only file for bankruptcy under Chapter 13 if they have less than   $465,275 in unsecured debt in cases filed between April 1, 2022, and March 31, 2025.

They must have less than $1,395,875 in secured debt (houses, cars for example) for cases filed between those same dates.

Under Chapter 13, you must design a 3–5-year repayment plan for creditors. Once you successfully complete the plan, the remaining debts are erased.

However, most people do not successfully finish their plans. When this happens, debtors may then choose to pursue a Chapter 7 bankruptcy. If they don’t succeed, creditors can resume their attempts to collect the full balance owed.

Chapter 11 Bankruptcy

Chapter 11 is often referred to as “reorganization bankruptcy” because it gives businesses a chance to operate while they restructure the debts and assets to pay back creditors.

This is used primarily by large corporations but can apply to any size of business, including partnerships and in some rare cases, individuals. Though the business continues to operate during bankruptcy proceedings, most business decisions require court permission.

There were 7,456 Chapter 11 filings in 2023, up from 4,918 in 2022.

Who Declares Bankruptcy?

Individuals file for bankruptcy at a far greater rate than businesses, and not just wealthy individuals trying to recover from bad investments.

Of the 452,990 bankruptcy cases filed in 2023, only 18,926 were filed by businesses. Median incomes for individuals filing Chapter 7 and Chapter 13 bankruptcies range from the low $40,000s-to-low-$50,000s.

The vast majority being individual filings stands to reason when you consider people may owe for a mortgage, credit card debt, auto loan or student loan – perhaps all four! – and don’t have the income to pay off that debt.

People also file bankruptcy as a financial planning tool that allows them to restructure their debt. Examples include the need to repay mortgage arrears or taxes.

While filing bankruptcy affects your credit and future ability to use money, people often effectively use it to prevent or delay foreclosure on a home and repossession of a car or stop wage garnishment.

Is Bankruptcy Right For Me?

When asking, “Should I file for bankruptcy?” think hard about how long it would realistically take to pay off your debt.

The bankruptcy code wasn’t designed to punish people forever. If some combination of bad luck and bad choices has devastated you financially – and you don’t see that changing in the next five years – bankruptcy could be your best option.

Even if you don’t qualify for bankruptcy, there is still hope for debt relief. Possible alternatives include a debt management program, a debt consolidation loan or debt settlement. Each typically requires 3-5 years to reach a resolution. None guarantees complete elimination of debt.

Don’t be fooled by how long Chapter 7 bankruptcy takes – the process itself is only 4-6 months. Instead, remember bankruptcy carries significant long-term penalties. It remains on your credit report for 7-10 years and makes it difficult to get future loans at reasonable rates.

The flip side is there is a great mental and emotional lift when all your debts are eliminated, and you’re given a fresh start.

» Learn More: Debt Relief vs Bankruptcy

Why Declare Bankruptcy?

Bankruptcy sometimes stems from unavoidable circumstances, or as a consequence of decisions beyond one’s total control.

“One of the biggest misconceptions about filing bankruptcy is that it means an individual has failed financially or is irresponsible with their finances,” Lyle Solomon of Oak View Law Group, said.

Here is a list of the most common reasons for filing bankruptcy:

• Divorce: The legal costs can sink you financially, let alone dealing with the fallout of marriage dissolution.
• A mountain of medical bills: According to a 2019 American Journal of Public Health report, 66.5% of bankruptcies were connected to medical expenses.
• Poor financial decisions: Excessive credit card use, often because of other budgeting issues, is another leading reason for bankruptcy filings.
• Job loss: If you don’t have a rainy-day fund – and many people don’t – job loss is a hole in the ceiling allowing debt to pour in.
• Unexpected emergencies: Theft or loss of property, natural disasters, etc. When you’re already living on a razor’s edge, unexpected events become financial catastrophes.

Having debts discharged through bankruptcy is a safe, legal and practical choice.  Choosing the right time, if possible, can help.

“When you are facing something like a foreclosure or a garnishment, bankruptcy tends to be one of the only options to stop those types of collection activities,” Morgan said. “So, sometimes your hand is forced about when to file.

“Alternatively, if you are not at one of those extremes, it is important to review your situation. If you are in a situation where you are living on credit because your pay is not enough to make ends meet, it may not be the right time to file. Most people won't have access to more than a small credit card or two for a while after bankruptcy.”

How to File for Bankruptcy

After exploring other options, you conclude that filing for bankruptcy can be a lifeline if handled correctly. What then?

It’s as important to know what not to do while filing bankruptcy as it is knowing the proper steps to have a successful filing.

Filing for bankruptcy is a legal process that either reduces, restructures, or eliminates your debts. Whether you get that opportunity is up to the bankruptcy court. You can file for bankruptcy on your own, or you can find a bankruptcy lawyer, which most experts regard as the most prudent avenue.

Bankruptcy costs include attorney fees and filing fees. If you can’t afford to hire an attorney, you may have options for free legal services. If you need help finding an affordable bankruptcy lawyer or locating free legal services, check with the American Bar Association for resources and information.

Before filing, educate yourself. It’s not simply a matter of telling a judge “I’m broke!” and asking for mercy. There is a process – a sometimes confusing, sometimes complicated process – that individuals and businesses must follow.

The steps for filing bankruptcy are:

• Compile financial records: List your debts, assets, income, and expenses. This gives you, anyone helping you, and eventually the court, a good understanding of your situation.
• Get credit counseling within 180 days before filing: You can’t file for bankruptcy until you’ve gone through a required bankruptcy counseling. It assures the court you have exhausted all other possibilities before filing for bankruptcy. The counselor must be from an approved provider listed on the U.S. Courts website. Most credit counseling agencies offer this service online or over the phone, and you receive a certificate of completion once it’s done that must be part of the paperwork you file. If you skip this step, your filing will be rejected.
• File the petition: If you haven’t hired a bankruptcy lawyer yet, this might be the time. Legal counsel is not a requirement for individuals filing for bankruptcy. You can try to file bankruptcy on your own, but you are taking a serious risk. Understanding federal and state bankruptcy laws is essential. Judges are not permitted to offer advice. Neither are court employees. There are many forms to complete and some important differences between Chapter 7 and Chapter 13. Not knowing proper procedures and rules could ruin your case. Without legal advice, you risk the bankruptcy trustee seizing and selling your property.
• Meet with creditors: When your petition is accepted, an appointed trustee sets up a meeting with your creditors. You must attend but your creditors are not required to be there. It’s an opportunity for them to ask you or the court trustee questions about your case.

» Learn More: Can You File Bankruptcy Online?

Pros and Cons of Bankruptcy

There are many good reasons for filing bankruptcy, but there are plenty of reasons for avoiding it, if possible. Here are the pros and cons of filing bankruptcy:

Pros of Bankruptcy

• The “automatic stay” provision in bankruptcy law means creditors cannot pursue action against you until the bankruptcy is discharged.
• Harassing phone calls from creditors stop.
• Filing bankruptcy provides a second chance to get your debt under control
• Depending on the type of bankruptcy filed, you may not have to repay some or all of your debt.
• A third-party court-appointed trustee will handle communication with your creditors and operate on your behalf.
• You can keep some protected assets in Chapter 7. In Chapter 13, you typically keep assets while repaying debt.
• Chapter 13 could allow you to prevent a foreclosure or auto repossession.
• Filing for bankruptcy impacts your credit score but your score could rebound as you go through the process of settling, especially if you consistently pay your bills after declaring bankruptcy.

Cons of Bankruptcy

• A bankruptcy discharge could prevent you from getting new lines of credit and may even cause problems when you apply for jobs.
• Depending on the type of bankruptcy filed, you could lose valuable assets, including your car and home.
• If federal student loans are the bulk of your debt, filing for bankruptcy won’t help. Only in rare cases is student debt dischargeable through a bankruptcy filing.
• The cost of filing bankruptcy is typically between $1,000-$2,000 if you don’t qualify for legal aid.
• Filing for bankruptcy stays on your credit report for 7-10 years.
• If friends and families have co-signed loans, they could be liable for repaying debt in a bankruptcy filing.
• You could have trouble gaining future credit, or offered higher interest credit, because you filed for bankruptcy.
• Bankruptcies are public information and could haunt you in future transactions or job interviews.
• While bankruptcy can be a lifeline, it also typically does not address the source of your financial distress.
• Because of the long-term consequences of bankruptcy, some experts say you need at least $15,000 in debt for bankruptcy to be beneficial.

» Learn More: How to File for Bankruptcy and Keep Your Car

Debts That Cannot Be Forgiven

Getting a “clean slate” through bankruptcy is a relative term. Bankruptcy does not erase all financial responsibilities.

It does not discharge the following types of debts and obligations:

• Federal student loans (unless you meet very strict criteria)
• Court-ordered alimony and child support
• Debts that arise after bankruptcy is filed
• Some debts incurred in the six months before filing bankruptcy
• Some taxes
• Loans obtained fraudulently
• Debts from personal injury while driving intoxicated

It also does not protect those who co-signed your debts. Your co-signer agreed to pay your loan if you didn’t or couldn’t pay. When you declare bankruptcy, your co-signer still may be legally obligated to pay all or part of your loan.

» Learn More: Can You File for Bankruptcy and Keep Your House?

Alternatives to Filing Bankruptcy

While bankruptcy can offer the best exit plan from crushing financial burden, it’s not a one-size-fits-all remedy.

If you’re uncomfortable with the credit score collateral damage of filing bankruptcy or some of the messier fallout of filing for bankruptcy, you may want to consider the alternatives:

• Call your loan servicer and inquire about a forbearance or loan modification.
• Negotiate with creditors on your own. Some creditors (looking to cut their losses) might agree to a repayment schedule that reduces your debt.
• A debt management plan, typically offered by nonprofit credit counseling agencies, is one way to pay off high interest credit card debt and get your debt under control through financial planning and budgeting.
• With a debt consolidation loan, a debtor can combine credit card debt with other debts in one monthly payment at a lower interest rate.
• You might consider debt settlement – an agreement reached between a creditor and a borrower in which a reduced payment is accepted as full payment. Just know debt settlement can damage your credit score along the same lines as bankruptcy.

If these options aren’t possible, it may be worth it to look into low-cost bankruptcy options.

Should I File for Bankruptcy?

Credit counseling is one of the procedural steps people must follow in order to file for bankruptcy. There’s good reason for that.

Credit counseling, particularly non-profit credit counseling, can also be a crucial step in avoiding bankruptcy.

“Any sort of education that can be provided regarding one’s finances and how to manage them can be beneficial,” Glatstian said. “Just be on the lookout for any for-profit company that claims they can magically make your debts go away without filing for bankruptcy. This is often a red flag.”

Conversely, working with a nonprofit credit counselor can put people on the road to making better financial decisions in myriad ways: budgeting, understanding relevant loan options and well-structured debt management programs that can reduce monthly payments and help rebuild poor credit.

A free consultation with a credit counseling agency can provide a debt analysis and personalized action plan based on your income and the amount and type of debt you’re carrying.

Most consultations can be done in a 30-minute phone call and provide important insight into whether bankruptcy vs. credit counseling is the right path for you.

Before deciding, it would also be wise to speak with legal counsel to determine your best option. To learn more about bankruptcy and other debt-relief options, read the Federal Trade Commission’s informational pages.