By Kristin O’Keeffe Merrick
We live in a world where facts are…fluid and in some cases largely ignored. We see this in the news cycle, in advertising and of course we see it when it comes to financial advice as well. My job is to dispel fact from fiction and clear up any money fogginess you may be dealing with. Recently, I had a conversation with someone who was dealing with credit card debt. Exasperated by the work involved in paying her debt, she exclaimed, “why can’t I just file for bankruptcy?”. She thought that we could wave a bankruptcy wand and it would just all go away. I am here to break down what bankruptcy is, how it works and the pros and cons of filing.
But first, it is time for the disclaimer part of the program. I am not an attorney. Filing for bankruptcy requires an attorney. Do not DIY this. Second, everyone’s financial situation is different. If you think you are a candidate, you should speak to an attorney and a financial advisor. Third, this entire piece is about an individual filing for bankruptcy, not a business. If you own a business and are considering this process, please seek legal counsel.
What Does It Mean To File For Bankruptcy?
Bankruptcy is a legal proceeding involving a person that is unable to repay outstanding debts. It is a proceeding carried out to allow that individual freedom from their debts. The bankruptcy process begins with a petition filed by the debtor (the more common route) or by the creditors (less common). Overall, the purpose of bankruptcy is to provide someone with a “fresh start”. Seems pretty great right? File a petition and POOF, your debt goes away. Let’s dig further.
When Does It Make Sense To File For Bankruptcy?
First, you need to assess your financial situation. Bankruptcy should be taken very seriously. Step one is to inventory all of your liquid assets. This means your cash, stocks, bonds, real estate, retirement accounts, college savings accounts, cars, etc. You will need to determine the value of these assets. Next you need to determine your liabilities. Liabilities are any debt that you owe. This includes any bills like credit cards, student loans, personal loans, car loans, mortgages, etc. If your liabilities far exceed your assets, bankruptcy may be an option for you.
Consider the following: Do you only make minimum payments on your credit cards? Do you use your credit cards to pay for necessities because you don’t have enough in your bank account? Are bill collectors calling you? Are you considering debt consolidation? Do you actually know how much money you owe to debt collectors? If you have answered yes to two or more of these questions, it may be time to consider the bankruptcy option.
Many people who file for bankruptcy do so because their situation is dire. One could be unemployed, drowning in medical bills, could have gone through a bad divorce. One of the more common reasons to file is because the person is simply drowning in credit card debt.
What Are The Benefits to Filing for Bankruptcy?
As mentioned earlier, filing for bankruptcy provides you with a fresh start from your staggering debt. The actual filing process discharges you from your many of your debts. It allows you the freedom to start over and make better decisions. Once you file for bankruptcy, the court will issue and an automatic stay. This means that creditors or other entities can no longer make collection attempts on your debts.
There are different types of bankruptcy filings. If you file for Chapter 7, there are certain bankruptcy “exemptions” that no one can seize such as your home, clothing, jewelry, and a variety of other personal belongings. More on this below.
Filing for Chapter 13 means that you don’t necessarily have your debts forgiven but can restructure your debt, lower your payments and have a better chance of getting out of debt.
Finally, many are concerned about their job when filing for bankruptcy. Under bankruptcy laws, you cannot be discriminated against by your employer for filing for bankruptcy.
What Are The Risks For Filing for Bankruptcy?
There is a great deal of stigma and embarrassment attached to filing for bankruptcy. This is a big hurdle for some people. Beyond that, there are some other risks worth noting. First, not all debt can be forgiven. Student loans and back taxes fall into this category. If you are looking for a way to get your student loans off your plate, this is not the way. Also if you owe back taxes, they cannot be forgiven in bankruptcy. The IRS always gets paid. Don’t forget that.
Another downside to filing for bankruptcy is that it will adversely affect your borrowing in the future. It is unlikely that you will be able to get a mortgage or a car loan in the near future. Even after many years have passed, you will likely be subject to higher interest rates. It could take several years to get your credit back to a good place.
When you file for bankruptcy, you relinquish ownership of your property to the bankruptcy court, and it becomes part of what’s known as the “bankruptcy estate”. The “trustee” (the person who is responsible for finding funds to pay your bills) holds the property on behalf of your creditors. Bankruptcy law allows you to “exempt” the things you need to maintain a home and job, such as household furnishings, clothing and an inexpensive car. These exemptions vary from state to state. In some cases, you can protect your retirement accounts by including them as exemptions. There is quite a bit of nuance involved in this exemption process. Please make sure to hire an attorney so you don’t make any mistakes.
How Do You File For Bankruptcy?
The first step is to determine that bankruptcy is your best option. You should consult an attorney and a financial professional like a financial advisor and/or a CPA. If you have determined that bankruptcy is the right path forward, you should retain legal counsel and begin the process of outlining your property exemptions. There is a great deal of paperwork involved and each state has a different process. Please be very thorough during this process.
What Are Some Alternatives to Filing For Bankruptcy?
One of the first steps to determining if you need to file for bankruptcy is to see if you can consolidate your debt in other ways. If you have credit card debt but have a decent credit score, you should consider consolidating with a different lender at a lower rate. You can also approach a bank to see if you would be eligible for a personal loan. You could then use the loan to pay off your credit cards and pay the loan off over time, ideally at a lower interest rate. Debt consolidation is a big business. Do your research and see if there is a solution for you!
Final thoughts: if you are truly in a dire situation and see no other alternative, perhaps bankruptcy is the path forward. Seek out good advice and make sure to follow all the steps carefully. Good luck!