Should I File for Bankruptcy?

The time to file bankruptcy arrives when every other method of debt relief has failed, and you still can’t pay your bills.

Nobody wants to file bankruptcy, but the unfortunate reality is that some people have to.

Bankruptcy can reduce or eliminate debt, allow you to stay in your home and lead to getting back on your financial feet.

“Bankruptcy is not a goal, it’s a tool,” said Marc Merklin, Partner and Chair of the Bankruptcy and Restructuring Group at the law firm Brouse McDowell in Akron, Ohio. “If creditors have judgments against you and are garnishing wages, that’s probably the time you know you have to file.”

There is a cost. Bankruptcy will affect your credit score, though as Merklin said that should be considered in perspective.

“You want to avoid bankruptcy if you can, but if you have multiple creditors with judgments against you, your credit’s already shot so there’s not much more damage you can do with bankruptcy,” said Merklin, whose firm provides bankruptcy support to clients nationwide.

If the bills are unmanageable and the financial walls are closing in, bankruptcy is an alternative that should be considered.

What Are the Main Causes of Bankruptcy?

The American Bankruptcy Institute lists three main causes of bankruptcy:

• Job loss
• Medical bills
• Divorce

Many times, two or three of those causes can team up and light a torch to your financial plans.

The American Bankruptcy Institute reports that personal bankruptcy filings increased from May of 2022 to May of 2023 by 23%. Chapter 13 bankruptcy, sometimes called ‘Wage Earners Bankruptcy’ increased by 23% the first six months of 2023. Chapter 11 filings, which are for businesses, increased by 68% over the first six months of 2023, according to Epiq Bankruptcy, a leading data group.

The resumption of student loan debts in the fall of 2023 – along with the Supreme Court’s decision not to allow the Biden administration’s partial forgiveness plan – could increase the financial burden on some and result in even higher percentage increases of bankruptcy.

Those who face any of the following should consider bankruptcy:

• Creditors are suing for debt payment.
• Your home is in danger of foreclosure.
• The only way to pay for necessities is with a credit card.
• You’re using one credit card to pay another (a very bad idea).
• You consider borrowing from a 401(k) account to pay bills.

“It’s always case by case,” Merklin said. “But if creditors are starting to grab at assets, wages, attach your car, grab money out of your bank accounts … at that point unless you can reach agreement with them it probably makes sense to consider bankruptcy. If you’re just being harassed by collection letters, it’s probably too early to file.”

Types of Bankruptcy

If you do decide to file, there are two main legal methods, called Chapter 7 for individuals, and Chapter 13 for some individuals and small businesses.

Chapter 7 is generally referred to as liquidation, which means a trustee sells your non-exempt assets, then uses the money to pay debts. Chapter 13 is a payment plan, which means the court and you agree on a payment plan to pay off your debts. Chapter 11 deals with business bankruptcy.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy allows individuals to liquidate, or sell, their assets, then use that money to pay debt. All under the court’s supervision of course. According to the Internal Revenue Service (IRS) Chapter 7 is available regardless of what is owed and whether a debtor is solvent. Those who file Chapter 7 will work with a court-appointed trustee who will oversee the process.

Chapter 7 does require a means test that will show whether a person can pay their debts without bankruptcy. If your income from the last six months is less than the state median, you qualify.

Some personal items and property are exempt from bankruptcy proceedings. These generally fall under the heading “necessary to live.” This means that a person’s home and car likely will be exempt along with clothing, appliances and computers or other items needed for the job.

Though a home without equity could be foreclosed on, in reality more than 90% of Chapter 7 filers stay in their homes.

What is not exempt? Think luxury goods. The extra car, a coin collection, a second home, the boat, excess jewelry.

Chapter 7 is best for filers who don’t want to have a lingering payment plan for the next 3-5 years. Chapter 7 works best for those who have credit cards, medical or personal loan debt.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy sets up a court-approved payment plan to eliminate debt. The payment plan can take 3-5 years to complete. Any individual may file, provided his or her total debts are lower than $2.75 million, according to the IRS.

This plan is for those with regular income who wish to keep their assets and have the means to meet the demands of the payment plan. The payment plan must strictly follow the court-approved agreement. If it is and the obligations are met, the bankruptcy will be discharged.

The main advantage to this plan is that it keeps any consideration of home foreclosure off the table. In fact, filing Chapter 13 stops foreclosure proceedings.

Instead of selling assets, the filer can combine, or consolidate, debts into one lump sum payment paid monthly. The filer promises to make the payments in a timely and regular fashion to meet the court’s requirement. The main factor that means Chapter 13 may be a bad idea: If the filer is irresponsible about making payments mandated by the court.

Things to Consider Before Filing for Bankruptcy

Before filing for bankruptcy, there are debt-relief options to consider. There are also some things you should avoid. The important thing if you are struggling financially is to understand you may have enough resources to right the ship, and not even realize it.

Talking to a counselor from a nonprofit credit counseling agency is a good first step, no matter what direction you end up going. The consultation is free. In the discussion the counselor will review your finances and discuss the pros and cons of debt management plans, debt consolidation loans and debt settlement, as well as bankruptcy.

It’s also wise to consult a bankruptcy attorney, even if you plan to file bankruptcy on your own. The initial consultation is free, and you may learn some valuable information about your bankruptcy case.

You may want to consider taking a second job or selling some assets to help pay down debt. Also, take a hard look at your debt. Is there a way to reduce interest or fees? Is it a temporary situation or a longer-term problem?

Also look ahead – if you have a big bill or big series of bills coming due, you may want to hold off until you see the full picture and then decide if you’re going to file for bankruptcy.

There are also some things you shouldn’t do if you’re seriously considering filing for bankruptcy:

• Don’t pay creditors or debt collectors.
• Don’t take on new debt.
• Don’t put anything (house, car, property, etc.) in someone else’s name.
• Avoid unusual transactions (like transferring property to a family member or friend).
• Don’t make payments to creditors you “like” prior to filing – the Court can force return of that payment if you pay one creditor more than $600 in the 90 days prior to filing, or one year if it’s money from friends or family.
• Take out loans shortly before filing.
• Don’t be misled about debt and income.
• Don’t touch your retirement funds.

What Are the Consequences of Bankruptcy?

Consider the consequences of bankruptcy when asking yourself if you should file. Among them:

• Credit score: Your credit score most likely already has taken a beating because of nonpayment, but filing for bankruptcy will hurt it further. It’s impossible to forecast exactly how far it will drop because too many factors are involved, but experts agree: The higher your score, the more you will fall. If you had a credit score above 700, a drop of somewhere around 200 points is likely. If you’re below 700, the drop could be more like 100-150 points. A Chapter 7 bankruptcy will remain on your credit report for 10 years and Chapter 13 will be there for seven years.
• Co-signers: If you have a loan that was co-signed by someone, that means they agreed to pay if you can’t. In Chapter 7 bankruptcy, the co-signer will still be on the hook to pay. Creditors can go after them for payment, even if your bankruptcy case is discharged (successful). Chapter 13 is a different story. The protective stay that prevents creditors from pursing payments once you file for Chapter 13 extends to the co-signers. The stay remains in effect as long as you make regular payments on your Chapter 13 agreement.
• Private life: Filing for bankruptcy means your name goes public. It’s not going to appear on a billboard downtown, but it is available to anyone with a PACER (Public Access to Court Electronic Records) account. The mandatory meeting with creditors occurs in a public forum and it appears on your credit report, for whomever has access to that. In some areas, it could appear in the legal notices of your local newspaper – though this is no longer widespread.

Can You Keep Your Home After Filing Bankruptcy?

The good news about bankruptcy and your home is that you won’t lose it – as long as you can make the monthly mortgage payments.

Merklin points out that most states exempt the home from consideration up to a certain amount of equity – which in Ohio is about $130,000. That means if your mortgage is less than that number, the home is not part of bankruptcy proceedings. Federal law caps the “homestead exemption” at $189,050 until March 31, 2025. This cap is designed to prevent people from shielding assets by moving to states with unlimited exemptions just prior to filing.

Remember that the purpose of bankruptcy is to give you a chance for a fresh start and it’s a lot easier to start over if you’re not homeless. That’s why bankruptcy laws make homes exempt from creditors’ claims.

However, if living in a house you can’t afford is part (or all) of the reason you’re filing for bankruptcy, then yes, you could lose your home.

If you fall behind on mortgage payments after filing Chapter 7, you can seek protection for your home by filing Chapter 13 to allow you time to catch up. Or, you may have to throw in the towel and let the bank foreclose.

In Chapter 13, it’s a little more complicated, but you essentially return to the default status you were in before declaring bankruptcy. You also will have to make the monthly bankruptcy payment, the mortgage payment and another payment to repay the mortgage company past-due amounts.

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

Can You Keep Your Car After Filing Bankruptcy?

The bankruptcy system is set up to allow people who file to keep their car. An auto loan is a secured debt – the car is the “security” that you will continue to pay. If you don’t, the lender will repossess your car. Bankruptcy discharges unsecured debt.

If you are still making payments on an auto loan, Chapter 7 allows you to “reaffirm” the loan or buy the car outright. Chapter 13 allows people to continue to pay their car loan under a structured plan, but the payments must be made on time.  Being up to date on your auto loan payments when you file for bankruptcy makes it more likely you’ll be able to keep it.

If you are no longer paying for your car, it’s an asset and must be listed with your assets, but you will likely be able to keep it.

Are There Any Benefits to Bankruptcy?

As painful as it may be, bankruptcy can lead to financial stability.

If you can’t find a way to get out of debt in the next five years – and have diligently researched solutions – then bankruptcy may benefit you.

Some of the benefits are:

• A second chance to stabilize finances
• A stop on calls and mail from debt collectors
• Improved long-term financial stability.
• An automatic stay, which halts foreclosures and other legal judgments on money you owe

Everyone’s situation is different, so weigh the pros and cons of bankruptcy as they relate to your financial situation and what you want in the future. Whatever position you’re in, don’t panic. There is a solution. You can’t go to jail just because you owe someone money, so find a way to fix the problem.

Bankruptcy Alternatives

It’s important to consider all options before filing bankruptcy. As we’ve said, the solution may be available with some careful study. Among the alternative to bankruptcy:

• Talk to your loan officer: Lenders do not want to lose money, so they may well listen if you call and ask for solutions on your debt. It might not work, but the call is free. Simply ask for available options that ensure the lender receives something and you have a less burdensome way to pay your debt.
• Forbearance/deferment of outstanding debts: Forbearance or deferment are temporary solutions that often are used to help with student loans. Deferment is the first option, and it involves delaying payments for periods of six months to three years. Those who face financial hardship could apply for deferment but must work to improve their financial situation while the loan(s) is (are) deferred. Forbearance is typically for those who do not qualify for deferment, which means you can apply to discontinue or reduce the number of payments for 12 months. Lenders must apply forbearance if the monthly loan payment is more than 20% of gross monthly income.
• Debt settlement: Debt settlement approach means negotiating an agreement with a lender to take less than is owed. Some lenders agree because it would receive something for the loan as opposed to a default, but there are serious considerations before taking this road – among them service charges, interest charges and late fees from for-profit debt settlement businesses. This business may promise to cut the loan by 50%, but once their fees and charges are considered the actual reduction is closer to 25%. A similar agreement with a nonprofit debt agency – called nonprofit debt settlement or Less Than Full Balance – typically will not include interest or other charges. Debt is reduced to 50-60% of what is owed, with payments spread evenly for 36 months. This is a new program, and you likely must search to find on that does.
• Increase income/cut expenses: This comes down to individual responsibility and decisions. And it’s important to remember that everything matters. Do you really need three movie channels on the cable package? Can you cut down on expenses for going out to eat? Can you eliminate extraneous subscription costs? All of them add up. Many may be surprised by what they can save when they cut household expenses.
• Make a budget (and stick to it): This is the second part of individual responsibility. Calculating where your money is going and comparing income to expenses can be eye-opening and can help save money. When you create a budget you have taken one of the more important steps in fiscal responsibility.
• Borrow money from friends or family members: A kind and supportive relative or friend could help you out of debt with reduced interest rates, or no interest at all. But if you borrow from family or friends, remember what you’re doing and be sure to repay the debt on time. There’s not much worse than taking advantage of the largesse of those close to you. Nobody wants to anger Aunt Agnes.

Next Steps

The answer to the question, “Should I file for bankruptcy?” depends on your financial situation. It depends on whether most of your debt is unsecured or secured; whether the consequences will do financial damage that will hurt your plans for the future; whether you can see another way to resolve your debt challenges – it’s all up to you.

If bankruptcy is the only choice that makes sense after researching all other options – and if you can’t pay off the debt in 3-5 years, then “Yes” you are a prime candidate to file bankruptcy.

The next steps, which will help guide you through the filing and court process are:

• Hire a bankruptcy attorney. The bankruptcy process is complicated, with many steps, deadlines, and forms to fill out. People who tackle it by themselves often aren’t successful in getting their debt discharged. A bankruptcy attorney generally costs around $1,500 for Chapter 7 and $3,500 for Chapter 13.

» Check here to see if you can reduce the cost of your bankruptcy filing: Low Cost Bankruptcy

• Pre-bankruptcy credit counseling. This is required for anyone filing bankruptcy. Credit counseling can also help you stay on track after your debt is discharged in Chapter 7 bankruptcy, or you’re in a 3-5 year Chapter 13 restructuring plan.

Whether you decide bankruptcy is right for you or not, meeting with a nonprofit credit counselor can help you figure out the best way to attack your debt and rebuild your credit.