Bankruptcy is a process through debtors may obtain court-ordered relief from their debts.
While for some debtors bankruptcy may be a valuable necessity, not everybody who faces financial difficulty should file for bankruptcy.
There is no quick and easy answer to the question of whether bankruptcy is right for you. You should discuss your situation with a credit counselor or a bankruptcy attorney, to evaluate the costs and benefits of bankruptcy given your personal financial situation. If you choose a credit counselor, verify that they're qualified with the bankruptcy court.
Consumers are required to go through credit counseling before filing a bankruptcy case, and it thus makes sense to work with a counselor whose services will satisfy that requirement rather than potentially having to go through credit counseling a second time.
Not every debtor qualifies to file for bankruptcy:
Chapter 7 Bankruptcy: To qualify for Chapter 7 bankruptcy, a debtor's incomes and assets are evaluated as part of a means test, designed to determine if debtors have the reasonable capacity to repay a portion of their debts. Debtors who exceed the test's income and asset limits must consider another form of bankruptcy, which reasonably speaking will be a Chapter 13 bankruptcy.
Chapter 13 Bankruptcy: To qualify for Chapter 13 bankruptcy, a debtor's non-contingent, unliquidated debts - those debts that are payable without regard for future contingencies, and for which a dollar value can be calculated - are subject to caps. Although the caps do not affect most debtors, a small number of debtors will be excluded from filing a Chapter 13 and may have to instead consider a much more expensive Chapter 11 bankruptcy, a type of bankruptcy normally used by businesses.
For more detail about factors that may affect the type of bankruptcy protection you might seek, read the article, Filing For Personal Bankruptcy Protection in a U.S. Court.
Even when debt seems overwhelming, debtors have a number of alternatives to bankruptcy. The question of whether an alternative is feasible, or is a better alternative to a bankruptcy petition, depends upon the facts of the debtor's situation and is thus an issue best evaluated by a competent credit counselor or bankruptcy lawyer.
Possible alternatives to bankruptcy include:
While the effective use of financial management requires that you give up a great deal of control of your finances, you may consider hiring a financial manager to handle your income and assets, to pay your bills, and to put you on an allowance until your finances are back in order. Financial management may be particularly helpful if your financial problems emerge from poor spending habits.
Some debtors may opt for a less intrusive form of management, such having a financial counselor help them create a budget that they may attempt to follow on their own.
Be careful when choosing a credit counselor or financial manager, as there are many self-professed counselors who will charge high fees but whose services may be of little value. Although it's an imperfect test of quality, consider utilizing a non-profit financial counseling service.
"Working Out" Your Debts
Some creditors will work with debtors, even waiving part of a delinquency or waiving interests on a debt, provided the debtor agrees to make payments on the debt.
Sophisticated creditors know that even if a debtor doesn't declare bankruptcy, some debts are very difficult to collect. Creditors and collection agencies may agree to take a percentage of the debt they collect as payment in full, as they know that litigation can be timely and expensive, and that aggressive collection may trigger a bankruptcy resulting in a smaller recovery or no recovery at all.
If you reach an agreement with a creditor, have the creditor confirm the agreement in writing before you make your payment. Also, keep in mind that some debt collectors may attempt to collect debts that are no longer enforceable due to the statute of limitations, and you should focus your negotiation on newer debts that remain enforceable through the courts.
If you own a home and have some equity in the home, consider refinancing your home to pay off all of your high interest debt. You may be able to obtain long-term financing at a much lower interest rate, allowing you to consolidate your debts, lower your monthly payments, and obtain a tax deduction in the process.
Be careful when dealing with companies that offer to combine all of your debts into a single "low payment" loan. Some loan consolidators collect large fees while offering a loan package that is inferior to that which you could obtain directly from a bank or credit union. A poorly structured loan may leave you paying interest for years, while making essentially no progress on paying down the principal of the loan.
If you have debts that you cannot afford to pay, and you cannot find an alternative to bankruptcy that will allow you to resolve your financial troubles, bankruptcy may be the correct choice for you.
If you decide to file for bankruptcy protection, consider the eligibility requirements for Chapter 11 and Chapter 13 bankruptcy. Most borrowers who qualify for a Chapter 7 discharge choose that option, due to its relatively rapid resolution and discharge of many debts.
Individuals who don't qualify for Chapter 7 bankruptcy or who might lose assets that they would prefer to keep through a Chapter 7 bankruptcy, will generally choose a Chapter 13 repayment plan, with a typical plan lasting five years. During the term of the repayment plan, the bankrupt individual's debts and payments are restructured, and upon the successful completion of the plan most debtors receive a partial discharge of their debts.
Whether before or after bankruptcy, many people are attracted to offers from companies that claim to "repair bad credit" or even to "remove" a bankruptcy from their credit history. Most such offers are fraudulent or result in only temporary removal while a dispute is being investigated.
For more information, please read our article about credit repair scams.