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Bankruptcy can help provide a financial fresh start, but it comes at a cost. You can expect a severe and long-lasting negative impact on your credit. That can make it difficult (or impossible, in some cases) to get approved for new loans and lines of credit. Whether the consequences of bankruptcy are worth it will depend on your unique financial situation.
Is Filing for Bankruptcy Bad?
Filing for bankruptcy isn't inherently bad, though it's generally seen as a last-resort option. Doing so can seriously damage your credit health and there are also upfront costs to consider. Depending on your circumstances, however, bankruptcy may be a lifeline that allows you to rebuild your financial life. Understanding the repercussions can help you decide if it's the right move for you. If not, there are several alternatives to bankruptcy that may be a better fit.
There are two types of bankruptcy, and each one has its own qualifying criteria.
| Chapter 7 Bankruptcy | Chapter 13 Bankruptcy | |
|---|---|---|
| Who it's for | Those who don't have enough income to cover their outstanding debt. | Those with enough income to afford at least partial repayment of their debts. |
| How it works | It erases many debts but may require you to forfeit certain assets. These are sold by a court-appointed trustee, and proceeds are divided among your creditors. | It establishes a short-term debt repayment plan, after which any remaining debts are forgiven. This allows you to retain more property than Chapter 7 bankruptcy. |
What Are the Downsides of Filing for Bankruptcy?
Opting for bankruptcy comes with pros and cons. Here are some important drawbacks to consider.
You Can Lose Your Home or Car
If you're behind on your car payments or mortgage, bankruptcy can temporarily prevent lenders from foreclosing on your house or repossessing your vehicle. It isn't a permanent fix, however. With Chapter 7 bankruptcy, creditors could eventually seize those assets since they serve as collateral. The trade-off is that you're free of the debt. A Chapter 13 bankruptcy can allow you to catch up on missed payments and ultimately keep your home or car, though you'll be responsible for paying some of what you owe.
You'll Pay Filing and Attorney Fees
Filing for bankruptcy may come with the following fees:
- A $78 court administrative fee.
- Additional court-imposed fees for various services, from certifying documents to filing amendments.
- Attorney's fees for Chapter 7 bankruptcy typically range from $1,500 to $2,000. For a Chapter 13 bankruptcy case, the range is generally anywhere from $3,500 to $6,500.
Your Credit Score Will Likely Suffer
Filing for bankruptcy has a serious negative effect on your credit. A Chapter 7 bankruptcy will remain on your credit reports for up to 10 years from the filing date. A Chapter 13 bankruptcy will stay for up to seven years. How much your credit scores decline will depend on your overall credit profile and the status of your credit health before the bankruptcy. In some situations, your credit score could decline by up to 200 points.
You May Have a Hard Time Getting New Credit
Some lenders may outright decline a credit card or loan application if there's a bankruptcy on your credit report. Others might approve your application, but with steep interest rates and fees. A subprime borrower who has a low credit score or poor credit history typically has a harder time qualifying for favorable rates and terms.
What Are the Benefits of Filing for Bankruptcy?
There's a reason people choose bankruptcy. In some cases, it may be the "best worst option." Here are some potential benefits.
You May Be Able to Eliminate Certain Debts
Chapter 7 bankruptcy allows you to discharge most debts relatively quickly—usually within three to five months of filing. That can provide a fresh start as you rebuild your finances. The following types of debt are generally discharged during a Chapter 7 bankruptcy:
- Credit card balances
- Mortgages
- Back rent and past-due utility bills
- Auto loans
- Personal loans
- Medical bills
- Payday loans
- Private loans owed to family or friends
However, student loans, child support, alimony and certain tax debts are not discharged in bankruptcy.
You Can Stop Many Collection Efforts
Once you've filed for bankruptcy, your creditors can no longer attempt to collect debts. That can provide temporary relief from vehicle repossession, home foreclosure or wage garnishment. Secured creditors, like mortgage and auto loan lenders, can eventually seize assets if debt payments stop.
With Chapter 7 bankruptcy, all your assets that are above an exempt amount are sold to pay your creditors. Any remaining unsecured debts are typically discharged. Chapter 13 bankruptcy restructures your debt and gives you a plan to repay what you owe over the course of three to five years. This option can allow you to keep your home or car.
You Can Start Rebuilding Your Finances
The main benefit of filing for bankruptcy is that it can offer a clean slate. Discharging or restructuring certain debts can significantly reduce financial pressure—and allow you to create a budget that feels manageable. From there, you can build up your emergency fund and save for other financial goals.
Should I File for Bankruptcy?
The answer depends on your financial situation and goals. Filing for bankruptcy is a serious financial decision, so you'll want to weigh the pros and cons and make sure you understand the repercussions beforehand. Having said that, here are some scenarios where bankruptcy might be a good option:
- Your debts substantially exceed what you can realistically repay.
- You're using debt to make payments on other debt.
- Collection actions or lawsuits are escalating.
- You're facing wage garnishment or potential foreclosure or vehicle repossession.
- Most of your debt may be dischargeable.
- A debt management or consolidation strategy won't realistically solve the problem.
- You've discussed your situation with a qualified credit counselor or bankruptcy attorney.
Alternatives to Bankruptcy
If bankruptcy doesn't feel like the right move, you aren't out of options. Below are some potential alternatives to consider.
- Credit counseling: A qualified nonprofit credit counselor can review your income and expenses and help you create a budget that works. That includes a plan for repaying your debts. The National Foundation for Credit Counseling (NFCC) and the Financial Counseling Association of America (FCAA) are two credible resources.
- Debt consolidation: This involves using a new loan or credit card to pay off one or more existing debts. Debt consolidation may unlock a lower interest rate and allow you to get debt-free faster.
- Debt management plan: A credit counselor can help you enroll in a debt management plan, which combines multiple unsecured debts into one new monthly payment. You pay the credit counseling agency each month, and they negotiate with your creditors and pay them on your behalf. Downsides with this option include fees and short-term credit damage.
- Debt settlement: This is when you negotiate with your creditors to pay a reduced amount. Debt settlement is often done through a debt relief company that instructs you to stop making payments as they negotiate for you. This can result in fees, credit damage and tax implications, but it could help you avoid bankruptcy and reduce your debt.
Frequently Asked Questions
What Happens When You File for Bankruptcy?
The bankruptcy process depends on whether you're filing for Chapter 7 or Chapter 13 bankruptcy. Both require you to complete a credit counseling course, pay a filing fee and provide necessary documents to a court-appointed trustee.
- Chapter 7 bankruptcy: There will be a meeting of your creditors to talk about your petition. Your court-appointed trustee will then liquidate your nonexempt assets and distribute the proceeds to your creditors. Any remaining debt is typically discharged.
- Chapter 13 bankruptcy: Like Chapter 7 bankruptcy, there will be a meeting of your creditors. After that, you'll attend a confirmation hearing to learn the status of your proposed repayment plan. Any debt that remains after your payment plan ends is typically discharged.
How Much Does it Cost to File Bankruptcy?
It costs $338 to file Chapter 7 bankruptcy, and $313 to file Chapter 13 bankruptcy. If you work with an attorney, fees can range from $1,500 to $6,500, depending on the type of bankruptcy you pursue.
Who Should Not File for Bankruptcy?
Bankruptcy isn't for everyone. It may not be the best option if:
- You could repay your debts by adjusting your budget or exploring debt consolidation or a debt management plan.
- You aren't behind on your debt payments.
- Most of your debt would not be discharged in bankruptcy.
- You're concerned about privacy. (Bankruptcy filings are public record.)
How Long Does Bankruptcy Affect Your Credit?
A Chapter 7 bankruptcy stays on your credit report for up to 10 years. A Chapter 13 bankruptcy stays for up to seven years. During this time, it can be difficult to qualify for new loans or lines of credit. If you do, you may be stuck with higher rates and fees.
The Bottom Line
The question isn't whether filing for bankruptcy is bad—it's whether bankruptcy is the right financial decision for you. Only you can answer that question, but a credit counselor or bankruptcy attorney can provide much-needed guidance. If you do opt for bankruptcy, you'll want to make a plan for rebuilding your finances going forward. That includes your credit health. You can get your credit report and FICO® Score☉ Θ for free from Experian.
