What’s the Downside of Filing for Bankruptcy?

If you’ve already tried everything to get out of debt and you’re still drowning, it’s normal to think that bankruptcy sounds almost too good to be true. After all, a Chapter 7 bankruptcy can eliminate your debts in as little as 4 months. Not to mention that the vast majority of personal bankruptcy filings actually allow the filer to keep all of their belongings. As with everything in life, there are some downsides to filing bankruptcy. Let’s take a look at what they are so you can decide whether filing bankruptcy is the right debt relief solution for you.

Bankruptcy Won't Solve All Your Problems

Filing any type of bankruptcy can be the solution to a number of problems, but whether you should file really only depends on whether it would solve your problems. Let’s take a look at some of the limitations of Chapter 7 bankruptcy. 

Some Debts Can’t Be Erased in Bankruptcy

Filing bankruptcy can provide you with a fresh start, but it’s not for everyone. Depending on the situation, there could be disadvantages to filing a Chapter 7 bankruptcy especially since not all debts can be eliminated with bankruptcy. The following list includes some of the most common non-dischargeable debts:

• Debts related to certain taxes such as tax debt from the last three years

• Alimony and child support payments

• Debts related to fraud or criminal matters such as court fines and penalties

• Secured debt that is reaffirmed

Since not all debts can be wiped out with bankruptcy, make a list of your dischargeable debts and non-dischargeable debts. If a large portion of your debt is non-dischargeable, then consider other forms of debt relief such as debt consolidation or a debt management plan. You may also want to get a free consultation with a bankruptcy attorney to see if Chapter 13 bankruptcy makes more sense for your situation.

Discharging Student Loans in Bankruptcy Requires an Extra Step (But It IS Possible)

There's a common misconception that bankruptcy can erase student loan debt, but this isn't true! Because many people believe this, most bankruptcy filers don't even try to get their student debt discharged. Don't make the same mistake!

To erase student loan debt, you'll have to file an adversary proceeding and prove that repaying the debt causes undue hardship.

To prove undue hardship, you'll have to show that:

• Your financial situation isn't likely to change (improve) during the student loan repayment period

• You've made a good faith effort to pay back the student loans

• You can't repay your debt and maintain a minimal standard of living

You'll hear this referred to as the Brunner test. Prior to late 2022, it was very difficult to prove undue hardship under the Brunner test, but it's since gotten easier... at least for federal student loans.

If You Want To Erase Private Student Loan Debt, You'll Probably Need To Hire a Lawyer Though

The process of discharging private student loans debt is the same: file bankruptcy, file an adversary proceeding, and prove undue hardship under the Brunner test. But the adversarial proceeding looks different for private student loan borrowers. It's much more difficult because it falls outside of the Department of Justice's new guidance. With private student loans, the adversary proceeding is run like a trial, which means to be successful, you'll probably want to hire a bankruptcy lawyer.

Sometimes Bankruptcy May Do More Harm Than Good (Depending on Your Financial Situation)

Now that your list separates your dischargeable debts from non-dischargeable debts, the next step is to compare your expenses to your net income (after taxes). Include domestic support obligations such as alimony and child support in your calculations. If you still have little to no money left over, or even worse, are negative, bankruptcy isn’t going to change that. Yes, you can get rid of your debt, but you may find yourself right back in a difficult financial position.

Filing bankruptcy at this point may even make your situation worse because if you later face a home foreclosure or car repossession (for a car you've reaffirmed) after you filed for bankruptcy, you will have to wait eight years before you can file Chapter 7 bankruptcy again. During this period, creditors can file lawsuits against you, place liens on your personal property and real estate, and garnish your wages.

The bottom line: If you can’t keep up with your financial obligations even after filing bankruptcy, then consider other options that reduce your expenses. Free credit counseling is a great place to start if you need help.

Your Credit Score Will Take a Hit

Yes, filing for bankruptcy will hurt your credit score. But by the time most people file for bankruptcy, their credit scores have already taken a serious hit due to missed or late payments, accounts in default, or even taking steps to deal with debt such as a debt settlement.

Many people who could otherwise benefit from bankruptcy avoid filing because they're worried about their credit score. But the truth is that your score is likely to suffer if you can't pay your debts on time, and sometimes bankruptcy is the first step on the path to rebuilding your credit. Upsolve has worked with thousands of Chapter 7 bankruptcy filers who've successfully raised their credit scores within months of filing their case.

You’ll Be Paying Higher Interest Rates for a While

If you have bad credit, chances are you were already paying a higher interest rate on your debts. After receiving a bankruptcy discharge, you may be surprised at how many offers you get for new credit cards or personal loans, but you will also be charged a higher interest rate than normal.

However, as you continue to rebuild your credit and make timely monthly payments, you will qualify for lower interest rates, saving you money. That’s why it’s important to rebuild your credit to improve your credit score.

You May Lose Items of Value (Though This Is Very Rare)

Chapter 7 is also known as liquidation bankruptcy because any property you own that isn't protected by an exemption can be sold. The money from the sale then goes to repay your creditors. Of course, this sounds very scary, and many people worry about losing everything if they file bankruptcy. The truth is that the vast majority of Chapter 7 filers get to keep all their property because it is protected by bankruptcy exemptions.

Exemptions apply to everything from household items, clothing, and tools to your car and home. That said, if you owe a lot of money on a car, you may have to surrender the vehicle as part of the bankruptcy case. Many Chapter 7 filers do not own homes, but if you do, only part of it will be protected with a homestead exemption. Cars and homes are slightly trickier situations than other types of property, but again, most Chapter 7 filers lose nothing but their debt.

Chapter 7 Bankruptcy Won't Protect Your Co-signers

Do you have co-signers on any of your debt? Sometimes there may be a co-signer because it was required by the lender or to get a lower interest rate, but regardless of the reason, a co-debtor is just as responsible for the debt as you are. Therefore, even though you received your discharge and are no longer responsible for that debt, your co-signer is. The only way to protect the co-signer is with a Chapter 13 bankruptcy, so long as the case remains pending.

Bankruptcy May Have Unintended Consequences

Did you owe money to a friend or family member and paid them back? Did your son or daughter just get their driver’s license and as a gift, you transferred your car to them? While you did the admirable thing by keeping your word with your friend and you will earn praises from your son/daughter, in bankruptcy court this could be a problem.

Paying back a friend for an outstanding debt could be considered preferential treatment and transferring the car to your son/daughter could be considered a fraudulent transfer. As a result, the trustee could sue your friend to get the money back or your son/daughter for the car.

Filing for bankruptcy too soon is another common mistake. For example, having to file bankruptcy because of medical bills and health related costs is common, but if you have future treatments and surgeries pending, there will be additional medical bills. If you didn’t include those debts in your Chapter 7 bankruptcy by filing too early, you will have to wait several years before you can file bankruptcy again.

It’s also important to understand the 180 day rule, and how it affects your bankruptcy case if you receive an inheritance after filing your case. For example, if you received an unexpected inheritance within 180 days of filing for bankruptcy, you are required to disclose that in your bankruptcy forms. It doesn’t even matter if you aren’t expected to receive the money for months or even years from the date you filed your Chapter 7 bankruptcy. The same applies to a personal injury case that happened before your case was filed. That money becomes part of the bankruptcy estate and, unless protected by an exemption, the trustee could be entitled to it.

Not Everyone Is Eligible To File Chapter 7

To qualify for bankruptcy, you have to pass what is known as the means test. To pass, the average of your last six months of income must be below the required state limits. If your income is over the limit, the second part of the test will determine if you’re able to pay at least a portion of your debts. If you don’t pass the means test, you can't file Chapter 7, but you may be bale to file Chapter 13 bankruptcy.

Sadly, the success rate for Chapter 13 bankruptcies is low. Only about 33% of Chapter 13 cases are successful versus 96% for Chapter 7 cases. The low success rate is likely tied to the 3–5 year repayment plan required in Chapter 13.

Because Chapter 13 bankruptcies are more complicated than Chapter 7 cases and have a much lower success rate, you shouldn’t consider filing a Chapter 13 on your own. Chapter 13 bankruptcies that are filed pro se (without the help of a lawyer) have less than a one-half of one percent (.5%) chance of getting approved by the bankruptcy court. If your case gets dismissed, you may have to wait six months before you can file again.

Filing Bankruptcy Can Be a Lot of Work

Here's the truth: Filing bankruptcy can be time consuming. The bankruptcy petition you file with the court is comprised of over 20 bankruptcy forms for Chapter 7. You have to be organized and diligent to fill out the forms completely and it can take a lot of time.

You'll need to review your credit report and any collection notices you’ve received in the mail to make sure all of your debts are included in your petition. You'll also need the last six months of pay stubs and with each pay period. Finally, you need to complete a credit counseling class. After filing for bankruptcy, you'll have to provide additional documentation to the bankruptcy trustee such as tax returns and bank statements. You also have to complete a financial management course.

If you fail to comply with all of these requirements, the bankruptcy court can dismiss your case without giving you a discharge or erasing your debts.

Ok, that's the bad new. Here's the good news: Upsolve can make the process a lot easier and help you prepare your paperwork for free. Upsolve has helped thousands of people just like you erase over $600 million of debt. Want to see if you're eligible? Fill out our free screener now.