The U.S. Bankruptcy Code can help alleviate the pressure when you are in a desperate financial situation. Qualifying individuals are permitted to file for a couple of types of personal bankruptcy through the court system to deal with their liabilities.
With a Chapter 7 bankruptcy (also known as liquidation), you can be formally absolved of certain debts and be freed of those pressing obligations. Chapter 13 bankruptcy can restructure many types of debt, allowing you to pay some debts in full and others in part or not at all.
Does bankruptcy sound attractive? It can be, but it’s not for everyone and should never be entered into lightly. Here are some signs that bankruptcy may be a viable option for you.
1. Most of Your Financial Obligations are Unsecured
Take a close look at your debts. If all or the majority of your accounts are unsecured, such as credit card bills, medical debt, collection accounts, and personal installment loans, you may be able to discharge them in a Chapter 7 bankruptcy.
Chapter 7 won’t help if most of your debts are secured by property, such as mortgages and car loans, or are for student loans, legal fines, child and spousal support arrearage, and/or back taxes.
In almost all cases, secured debts can’t be discharged, so you’ll be stuck with them.
2. You Can Prove That You Can’t Satisfy Your Financial Obligations
To use Chapter 7 bankruptcy protection, you may have to pass a means test, which determines whether you are eligible for this type of relief. To find out, visit the United States Department of Justice website.
You will compare your gross household income to the median household income for a family of the same size in your state.
You don’t have to pass the means test if you earn less than the median household income for your state. But if you earn more than that figure, you will — and will have to go through some heavy calculations to prove that you can’t currently pay your bills nor will you be able to in the near future.
3. Your Home is at Risk of Foreclosure
If you are behind on mortgage payments, you may be in danger of losing your home to foreclosure. Chapter 13 bankruptcy can come to your rescue. It stops a foreclosure from moving forward.
You can keep your home if you can pay your missed payments. The repayment period is up to five years. Not only can you catch up on missed mortgage payments, but you can also include back car loan payments and debts not dischargeable in Chapter 7.
After you’ve completed the plan, you will receive a Chapter 13 discharge that wipes out most of your remaining debts. But this type of bankruptcy is very complicated.
It involves a trustee to administer the case, and you will need to prove to the court and to your mortgage lender that you can afford to make the regular payments until it’s satisfied. Your disposable income will be reviewed, and you will have to adjust your budget if you’re spending on luxuries (based on IRS National Standards).
4. Your Life Will Vastly Improve by Filing for Bankruptcy
Chapter 7 bankruptcy is the most common type of personal bankruptcy because you no longer have to pay the bills that are weighing you down. But before pursuing bankruptcy protection, think about how it may impact your life.
It’s hard to know for sure, but you’ll want to consider the psychological impact it can have.
Ask yourself some key questions. Do you think you’ll feel happy, guilty, depressed, or relieved? Will you feel emotionally and financially prepared to rebuild your life so you don’t have to go through this again?
Bankruptcy filings are a matter of public record, so you’ll need to be OK with the possibility that nosey people can find out if they really want to check.
5. You Do Not Have Important Property to Lose
It is important to take stock of what you own because you must list those assets when you complete the bankruptcy paperwork. Check out the exemption list for your own state here.
If you have property you don’t want to lose, reconsider filing for Chapter 7 bankruptcy because it will be at the risk of liquidating your assets.
Every state has different exemptions, which includes the property you get to keep after your debts are forgiven. Essential items such as furniture, clothes, and a vehicle that you need for work and school are typically exempt, but luxury items are not.
Luxury items can include designer watches, antiques, expensive vehicles, boats, and recent credit card balances incurred for luxury items.
6. You Can Handle the Negative Credit Impact
While it may be difficult to think ahead when you are under financial pressure and want to make the problem disappear, you must consider your long-term goals.
Even if you can file for bankruptcy, you may choose not to because it can impact upcoming financial plans. Do you want to start your own business? Purchase a house or car?
Appealing to a lender with a bankruptcy on your credit report can be a challenge. Chapter 7 bankruptcies stay on credit reports for 10 years from the filing date, and Chapter 13 bankruptcies are reported for seven years.
While getting a loan or credit product with a bankruptcy notation is certainly possible, it will be more difficult and the borrowing terms will be less attractive. You will probably want to rebuild your credit, which requires using credit products advantageously.
7. You Don’t Have Underlying Spending Issues (or You’ve Already Resolved Them)
What is the reason for the consumer debt you have now? If it is because of an unanticipated job loss or several large expenses, such as hospital bills, you could not avoid, bankruptcy can help.
But if you got into credit card debt because you were not managing your financial affairs well and charged what you couldn’t afford — and have not yet solved those issues — there’s a high likelihood that you will end up underwater again.
Many credit card companies will extend credit to people who have declared bankruptcy because they no longer have financial obligations to cover, and they can’t file for bankruptcy again for eight years. You must be extra certain to only charge what you can afford to repay in full by the due date.
8. You’re Not “Judgment Proof”
Creditors have the right to take you to court to seek financial damages if you don’t repay your debt. Filing for bankruptcy can protect your assets from being seized and your wages from being garnished.
So what happens if you don’t have assets and wages that creditors can take if they win? Outside of credit damage, not much.
You may be considered “judgment proof,” which means that even if the creditor takes you to court and wins a monetary judgment against you, it won’t receive anything for its troubles.
Creditors can still contact you, but, as per the Fair Debt Collection Practices Act, you can send a cease and desist letter. Upon receipt, the creditor will either have to notify you that it will take legal action or stop contact.
If you explain that you have no money and no assets, creditors may decide to drop matters completely. This also applies to debts that have passed the statute of limitations for lawsuits in your state.
The Bottom Line on Bankruptcy Decisions
Bankruptcy is a powerful tool available to many individuals. A Chapter 7 bankruptcy can give you a much needed fresh start, so all the money you had been sending to your creditors can go back into your family’s budget. A Chapter 13 can offer valuable asset protection and the opportunity to repay your creditors over time.
If you feel that bankruptcy is an option you want to pursue, make an appointment with a credit counseling agency that has been approved to conduct pre-bankruptcy counseling by the United States Department of Justice.
All individuals are required to take this specialized credit counseling and pre-discharge reduction course. Once done, you’ll have a better idea if you can manage your debt obligations on your own or whether taking care of them in court is the best action for you.