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When You Need to File Bankruptcy

Believe it or not, bankruptcy is not a dirty word. Yes, it’s far better to never go into bankruptcy. Most people seem to get that. But what many do not understand is that sometimes, bankruptcy isn’t just a way to protect yourself from creditors—it is sometimes the best financial decision you can make.

Dire Situations…

I received an email last week from a reader in dire financial straights. She and her husband (with three kids):

  • Have been out of work for a year
  • Have seen their monthly income fall from $4,000 to less than $1,200
  • Kept the rent paid, but have fallen behind on other bills
  • Have had two cards repossessed
  • Were sued by at least one creditor, who successfully obtained a collection judgment

…Require Dire Measures

In this case—unless this couple holds particular assets they are trying to protect—I think it’s time to declare bankruptcy. In fact, the couple may have been able to avoid losing their cards—and being sued—by declaring bankruptcy a while ago.

Overcoming Ethical Dilemmas

This reader explained she did not want to file bankruptcy because she acknowledged she and her husband owe the money, and they don’t want a cop out. It takes a great deal of responsibility to feel that way, but I would say to them, consider these facts:

  • Bankruptcy is designed to help good people who get into financial trouble—people like you—avoid losing the roof over your head and the food on your table because of credit card debt
  • You’re not “abusing the system” so long as you did not go into debt expecting to file bankruptcy and never repay your debts
  • The creditors that lent you money willingly assumed the risk that you wouldn’t be able to repay your debts—that risk is a part of their business
  • Under Chapter 13 bankruptcy, you will still repay a portion of your debts over 3-5 years, based upon your income and budget.
  • Your future credit may not be any worse after filing bankruptcy than it already is from a year of late payments and judgments against you

Bankruptcy’s Number One Benefit: The Stay

When creditors resort to litigation to collect an unpaid debt, the consumer faces a losing battle. Certain lawyers do nothing but argue on behalf of credit card companies. These lawyers don’t know—and don’t care—about the specifics of your case, only that you owe their client money. And unless you appear in court and present a valid legal argument against it—they will persuade the court to make your debt legally collectible (as in the judgment my reader received).

This judgment results in a really bad mark on your credit card for up to ten years, and means that failing to repay the debt could result in the creditor legally garnishing your wages (taking money directly from your paycheck, like taxes), forcing you to sell assets, or even tapping directly into your bank account.

The minute you file bankruptcy, however, an automatic stay is ordered on all collection efforts and litigation against you. Basically, when you file bankruptcy, anybody to whom you owe money must prove to a bankruptcy judge that you do in fact, owe them money. The judge will then decide, based upon your income and assets, who gets paid what.

Chapter 7 vs. Chapter 13 Bankruptcy

In 2005, Congress passed a bankruptcy reform bill that made it more difficult for Americans to file bankruptcy. For example, debtors must now undergo credit counseling prior to filing. Under existing bankruptcy law, there are two ways to file bankruptcy: Chapter 7 and chapter 13.

In chapter 7 bankruptcy, a court will liquidate any assets you own in excess of some minimal property (your home, a car, a computer, a TV, clothes, etc.) to repay your debts. The court will then discharge any debts remaining. To qualify for chapter 7 bankruptcy, however, filers must earn less than the median income in that filer’s state, or meet other specific criteria.

Most debtors will file chapter 13 bankruptcy. In chapter 13 bankruptcy, a judge will determine a three to five year payment schedule based upon the debtor’s income and assets. After successful completion of the payments, any remaining debts will be discharged.

Filing Bankruptcy, First Steps

If you think you may be a candidate for bankruptcy, start gathering as much information as you can as early as possible. Although you can learn a lot onlin about the pros and cons of bankruptcy—and what to expect if you file—you’ll want a lawyer that specializes in bankruptcy to actually go through with filing.

Bankruptcy filing fees and your lawyer’s fees are apt to cost anywhere from $1,000 to several thousand dollars, which is another reason why the decision to file bankruptcy should be made extremely carefully. If, however, creditors are already pursuing you in court, and bankruptcy will help keep the roof over your head and food on the table, those costs—and the other downfalls to bankruptcy—may just be worth it.

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

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