When Should You File for Bankruptcy?

Millions of Americans feel overwhelmed by debt, but that doesn’t mean all of them should file bankruptcy. There are multiple paths to debt relief, depending on your unique circumstances. Bankruptcy is only one. However, when other possible solutions, such as debt settlement and debt consolidation fall short, bankruptcy may be the most effective way to discharge debt and get the fresh start you need. Read on for more information about the different types of bankruptcy, and how to determine if filing might be right for you. 

When Should You Consider Filing Bankruptcy

Generally speaking, a bankruptcy filing is used as a last resort. It is meant to help people and businesses with debt they can’t afford to pay, and for whom the hardship is expected to continue for an extended period of time. Although it is usually a good idea to first consider bankruptcy alternatives, there should be no shame in filing if you choose to go this route. Excessive debt plagues millions, and the current economic crisis is likely to increase these numbers exponentially. 

To make the most informed decision possible, it’s in your best interest to consider multiple debt relief solutions before determining which option is right for you. Some alternatives to bankruptcy include: 

• Debt consolidation

• Debt management

• Debt settlement

Each of these alternatives to bankruptcy is discussed in great detail later in this article. But a reduction in overall debt may still be more than you can afford to pay. In this case, bankruptcy, which involves the liquidation or reorganization and discharge of debts, might be the only viable solution. Filing bankruptcy will negatively impact your credit score and remain on your credit report for up to 10 years, but for many people, it is the most effective way to wipe the slate clean and begin rebuilding a solid financial future. But which type of bankruptcy should you file? 

Chapter 7 and Chapter 13: The Two Main Types of Bankruptcy

In personal bankruptcy, Chapter 7 and Chapter 13 are most common. Chapter 11 is also an option, although it is more frequently utilized for businesses. Chapter 7 bankruptcy involves the liquidation of unsecured debts, such as credit card debt and medical bills, while Chapter 13 allows debtors to reorganize their unsecured and secured debt into a three-to-five year repayment plan. In most cases, any remaining debt will be eliminated at the end of that repayment period. However, both Chapter 7 and Chapter 13 have qualifying factors that must be met in order to file. 

When Should You File Chapter 7 Bankruptcy

Once you have decided that bankruptcy is the best debt relief solution for you, it’s important to determine which type of bankruptcy will align with your situation and goals. Chapter 7 may be best if most or all of your debt is unsecured. Examples of unsecured debt include credit cards, medical bills, personal loans, unpaid utility bills that have gone to collections, and deficiencies on vehicle loans after repossession. 

In order to qualify for Chapter 7 bankruptcy, however, you must be able to pass something called the means test, which proves that your income is less than the median income in your state, or, if not, shows that you don’t have sufficient disposable income. If your monthly income is too high to pass the means test, you may need to consider filing Chapter 13 instead. 

Chapter 7 is best for individuals who are overwhelmed by unsecured debt, whose wages may be subject to garnishment, and who are not at risk of losing nonexempt assets, which can be sold by the bankruptcy trustee to pay off unsecured creditors in the Chapter 7 bankruptcy process. Examples of non-exempt assets may include:

• Cash

• Stocks, bonds, and other investments

• A portion of equity in a primary residence

• A second vehicle

• A second home

• Family heirlooms

The main concerns regarding nonexempt assets are usually the debtor’s primary residence and vehicle. Although bankruptcy exemptions protect these assets up to a certain point, they can be at risk in some situations. Most states provide a homestead exemption for a person’s primary residence, which protects the property up to a certain dollar amount. Depending on the state, and whether the homeowner uses a state or federal exemption, the protection could range from a few thousand dollars to more than $500,000. If you have less equity than the dollar amount of your exemption, your home is safe from the bankruptcy trustee.  

If you are considering Chapter 7 bankruptcy and are concerned about keeping your home, an experienced bankruptcy attorney can help you determine how to proceed.

When Should You File Chapter 13 Bankruptcy

If your income was too high to qualify for Chapter 7, or you have significant secured debt, Chapter 13 bankruptcy might be the right choice for you. In Chapter 13, your debts are reorganized, rather than liquidated, and repaid over a three-to-five year monthly payment plan. Secured debts including mortgage arrears and underwater vehicle loans with high interest rates, can be included in repayment plans, essentially bringing you current. Other non-dischargeable debts, such as back income taxes, student loans (in some cases), alimony, and child support, can also be included in a Chapter 13 repayment plan. 

In order to qualify for Chapter 13, the debtor must not have excessive unsecured debt, such as credit cards and medical bills and you can’t have a multi-million dollar mortgage. If you wish to file Chapter 13 bankruptcy, but have too much unsecured debt, you may be able to take advantage of a process called Chapter 20, which involves filing Chapter 7 first to wipe out unsecured debt, and filing Chapter 13 after. 

Finding Your Path to Lasting Debt Relief Through Credit Counseling

As mentioned earlier, there are multiple alternatives to bankruptcy. Taking advantage of free credit counseling can help to ensure that you choose the best debt relief solution for your situation. Credit counseling agencies offer free counseling to overwhelmed debtors, and taking them up on that offer can provide invaluable benefits. Some of the most common alternatives to filing bankruptcy include: 

Debt Consolidation

Debt consolidation may be an option if you haven’t fallen too far behind on loan payments yet. If your credit is still relatively good, you can consolidate all of your debt payments into one, resulting in a lower interest rate, and a lower monthly payment. Debt consolidation will not negatively impact your credit score, but it is rarely an option for people who are already far behind on payments. Since it involves getting a new loan, you must have a decent credit score to qualify. 

Debt Management Plans

A debt management plan is the next logical solution if your current monthly payments are just a bit more than you can handle, and your credit is less-than-perfect. Step one of a debt management plan is to meet with a credit counselor at a credit counseling agency. This consultation is entirely free, even if you don’t decide to go with the suggested debt management plan. You will walk away from the session with a better understanding of your overall financial picture, and which form of debt relief is likely best for you. If you do decide to move forward with debt management, the agency will negotiate with your creditors for a more agreeable payment plan. The intention is to pay the full amount owed, but creditors are often willing to lower your interest rate and create a repayment plan that more closely aligns with your current financial situation. 

Instead of making multiple monthly payments to different creditors, you will make one monthly payment to the debt management company, which will in turn pay your creditors on your behalf. And you need to complete pre-bankruptcy credit counseling before a bankruptcy anyway, so if you ultimately decide to file, you will have already fulfilled this prerequisite. 

Debt Settlement

Debt settlement is another option. If your total debt is well beyond what you can afford to pay, even with lower interest rates and more favorable terms, you may wish to go this route. Debt settlement can be done on your own or through a debt settlement company. The process involves negotiating with creditors to settle your debts for less than what you actually owe. Although it still has a negative impact on your credit score, debt settlement - if it can be done quickly and successfully with all of your creditors - may be less of a black mark than bankruptcy. 

If you are comfortable dealing with creditors directly, you can contact them on your own and try to negotiate for a reasonable settlement. If, however, the thought of dealing with creditors makes you want to run screaming, you may wish to work with a debt settlement company. When choosing this option, make sure that you are working with a reputable company. Debt settlement is a legitimate business and many companies offer real solutions to help clients get out of debt. But many scams exist. Just do your homework, and check with the Better Business Bureau before deciding which company to work with. 

Conclusion

Deciding how to get out of debt and begin rebuilding your financial future is very personal. And there is no one-size-fits-all solution. At Upsolve, we offer free educational information and tools to help low-income debtors save money and make the most informed decisions possible. Visit our Learning Center for more information. Upsolve offers a web app that eligible individuals can use to file Chapter 7 bankruptcy on their own, completely free. In addition to Upsolve’s complementary information and tools, most bankruptcy lawyers offer free legal advice at the initial consultation, which we highly recommend all debtors take advantage of before moving forward with any debt relief program. Bankruptcy laws are constantly changing, and more complex bankruptcy cases can derive immense benefit from skilled legal counsel.