When Does It Make Sense to File for Bankruptcy?

Bankruptcy should be avoided whenever possible, but there are times when people who are overwhelmed with debt have no viable alternative but to seek bankruptcy relief.

Bankruptcy laws are designed to ease the financial pressure on people who can’t pay their bills. While filing for bankruptcy can erase unsecured debts, prevent foreclosures, and stop debt collection activity, it has some drawbacks, said debt resolution attorney Leslie Tayne. Going through bankruptcy can affect your credit report for up to 10 years, making it difficult to qualify for a mortgage, a car loan, or other lines of credit, Tayne said.

For most individuals, there are two types of bankruptcy: liquidation (Chapter 7) and reorganization (Chapter 13). “There are other chapters of bankruptcy, but for most consumers, these are the two available options,” Tayne said. Depending on individual circumstances, most of your debts may be discharged or reorganized to create a manageable repayment plan.

A last resort

Deciding when to file for bankruptcy can be a difficult judgment call. It depends, in part, on your tolerance for living with the stress of being deeply in debt.

Experts generally agree that bankruptcy should be entered into as a last resort. You should consider it “when you can no longer afford basic necessities and all other options have been explored and exhausted,” advised Tayne.

Attorney Jen Grondahl Lee said the time to file for bankruptcy is “when you are so stressed from your finances that you cannot see the light at the end of the tunnel.” And attorney Parisa Fishback said bankruptcy may be appropriate if you have property that’s in danger of going into foreclosure, or if you’re thinking of taking money out of a retirement account in order to pay an unsecured debt.

Before you decide to seek bankruptcy protection, consider taking the following steps:

Get a handle on your finances. First, add up your assets, including your savings accounts, the value of your home and your automobile, your retirement funds, and any investments you have. Next, tally your liabilities, including all bills and obligations. These include outstanding loans and credit card debt. If your liabilities are far greater than your assets, it may be time to consult an attorney about bankruptcy. Understanding your assets and liabilities “will put you in the best position to make a decision on bankruptcy,” said New Jersey attorney Paul J. Riviere.
Try to negotiate with your creditors. Many creditors would rather make a deal than see you file for bankruptcy. That’s because some or all of the money you owe them could be discharged in court. You may be able to convince your creditors to forgive part of your debt or agree to a more manageable repayment plan. Consider contacting a nonprofit credit counseling agency that’s accustomed to working with lenders and credit card companies.
Make sure you’ve exhausted all alternatives. Borrowing money from relatives to repay your debts or selling property to raise money may be preferable to bankruptcy, depending on your circumstances.
Prepare for the job of starting over financially. This means changing your spending and bill-paying habits in order to make sure you never again find yourself in this situation. For example, if your financial problems were caused by credit card debt, you should be willing to stop relying on credit cards for your day-to-day needs. This will be easier if you commit to building an emergency fund you can use for unexpected expenses, such as car repairs.

Make peace with your bankruptcy

Once you’ve made the decision to declare bankruptcy, don’t waste time feeling guilty or dwelling on the damage that has been done to your credit report. Your credit score can start to recover in just a few years, so learn from the past and focus on the future.

Having a bankruptcy on your record means you likely will have to pay higher interest rates for loans, because you’ll be considered a greater credit risk. Although it can take up to 10 years for a bankruptcy to fall off of your credit report, the impact will diminish over time.

Florida consumer protection attorney Donald E. Petersen said it can take two to three years for your creditworthiness to recover enough to allow you to obtain a home loan on favorable terms. Be aware that there are predatory lenders who work with people with damaged credit in order to charge higher interest rates. Consider putting off major purchases that require borrowing until your credit rating improves.

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