A few weeks ago I was listening to a financial radio show on a day when every other caller wanted to know if they should file bankruptcy.
One man was dealing with estranged spouses (yes, plural), a failed business, and hundreds of thousands in debt. It was no surprise he was considering bankruptcy. From there, however, callers’ reasons for wanting to file bankruptcy grew far less convincing. One caller even wanted to know if her 24-year old son should file bankruptcy over a $15,000 credit card debt.
Bankruptcy in this country has its place. Ideally, bankruptcy serves debtors who are in such a hole that there is truly no other way out. Unfortunately, however, many Americans see bankruptcy as the “easy way out” of debt—just like we snatch up diet pills and a lotto tickets.
If you’re struggling with a frightening amount of debt (or know somebody who is), here’s a quick reminder of why bankruptcy should still be avoided and only used as a true last resort.
What Bankruptcy Does
Here’s the 60-second primer: Bankruptcy is designed to protect the truly insolvent from unaffordable debt. There are two kinds of individual bankruptcy: Chapter 7 and Chapter 13.
- Under Chapter 7 bankruptcy, filers must liquidate personal assets to pay some debts, but many other debts may be discharged. Debtors must meet certain income requirements to file Chapter 7 bankruptcy.
- Chapter 13 bankruptcy odes not eliminate debt; it establishes a court-supervised repayment plan over three to five years.
Although bankruptcy can help debtors eliminate or repay many unsecured debts like credit card and medical bills, bankruptcy does not eliminate many debts including alimony, student loans, criminal judgments, and tax debts.
Why Avoid Bankruptcy
Ruined Credit. Unsurprisingly, bankruptcy ruins your credit (if you had any left before filing). Bankruptcy stays on your credit report for at least seven and up to 10 years. That does not, however, mean that once that time has passed, you have a clean slate. Many financial applications and background checks ask if you have ever filed bankruptcy. Not in the last 10 years. Ever. Bankruptcy will follow you for life.
Expensive Borrowing. Most unsecured credit cards will flat out reject applicants with a recent bankruptcy. You may be able to arrange for a mortgage or an auto loan in time, but you may need to put up to 50 percent down and pay ridiculously high interest rates.
Filing is Tricky and Costly. Legislation enacted in 2005 makes it harder to file bankruptcy. Filers must go through credit counseling at their expense six months before filing for bankruptcy and must take a financial education class afterward. Finally, even though bankruptcy is designed for broke people, it is far from free. You can expect to pay, at the very least, $1,000 in filing fees and attorney fees.
Alternatives to Bankruptcy
The best way out of debt will always be to man up and face your debt head-on. That means making a debt repayment plan and paying up—whatever it takes.
If you need help, there are legitimate organizations that can help, like the National Foundation for Credit Counseling (800-388-2227, www.nfcc.org).
- Need Help? Learn How to Get a Free Debt Consultation
If you’ve made significant efforts on your own to repay your debts and have already tried getting help from one of the above sources—especially if you owe more than you earn in a year—bankruptcy may be an option. Just do your homework and ensure you have exhausted other options before you proceed.
Finally, if you do go forward, find and hire an attorney you trust.