Originally Published on Feb 1, 2017
This is a great article on when bankruptcy is the best option, with a lot of great points but you never want to do anything without first discussing it with an attorney. If you borrow money from friends and family not only do you have to include them as a creditor in the bankruptcy, you cannot repay them until after the bankruptcy is complete.
If you stop paying your credit cards and consumer debt and find out you are not eligible to file a bankruptcy, you risk getting sued.
Furthermore, if you choose to sell something, it could very well be something that may have been exempt.
Howard Rabb, Partner, Dworken & Bernstein Co., L.P.A.
When Bankruptcy is the Best Option
Bankruptcy isn’t the end of the world. It may even be good for you.
Bankruptcy stops collection calls, lawsuits, and wage garnishments. It erases the debt. And despite what you’ve heard, bankruptcy may help your credit scores.
Credit bureaus and scoring experts often say bankruptcy is the single worst thing you can do to your scores. Foreclosures, repossessions, charge-offs, collections — nothing else can drive your scores down as fast and far as a bankruptcy.
But that’s not the whole story. Most people struggle so long with their debt that their credit is already battered by the time they file for bankruptcy. And once they do, their scores typically rise, not fall. If the debt is erased — which is known in bankruptcy court as a “discharge” — scores go up even more.
“Within a year, you’re way better off,” says Jaromir Nosal, assistant professor of economics at Boston College, who co-authored a study for the Federal Reserve Bank of New York about the effects of bankruptcy. “It’s a pretty rapid rate of recovery.”
Saving your credit score is only one reason
Credit scores aren’t the only factor to consider, of course. Some of the others:
An end to collection hell: Nosal’s study found that once people fell seriously behind on their debt — with at least one account 120 days overdue, for example — their financial troubles tended to get worse. Balances in collections and the percentage of people with court judgments grew.
By contrast, people who file for bankruptcy benefit from its “automatic stay,” which halts almost all collection efforts, including lawsuits and wage garnishment. If the underlying debt is erased, the lawsuits and garnishment end.
Freedom from certain debts: Chapter 7 bankruptcy wipes out many kinds of debt, including:
- Credit card debt.
- Medical bills.
- Personal loans.
- Civil judgments (except for fraud).
- Past-due rent.
- Past-due utility bills.
- Business Debts.
- Some older tax debts.
Some debts, including child support and recent tax debt, can’t be erased in bankruptcy. Student loan debt can be, but it’s very rare. But if your most troublesome debt can’t be discharged, erasing other debts could give you the room you need to repay what remains.
Better access to credit: It can be difficult to get credit right after a bankruptcy. But Nosal’s study shows people who have completed bankruptcy are more likely to be granted new credit lines within 18 months than are people who fell 120 days or more overdue at the same time but didn’t file.
Your credit limits after bankruptcy are likely to be low, however, and your access to credit — like your credit scores — won’t recover completely until a Chapter 7 bankruptcy drops off your credit reports after 10 years.
That’s a long time in the penalty box. But let’s dispense with the idea that people facing bankruptcy are choosing between paying their bills and not paying their bills.
When to stop digging a hole you can’t escape
Most of us feel we have a moral obligation to pay what we owe — if we can. But typically that ship has sailed by the time people realize they need to consider bankruptcy. They can continue trying to chip away at debts they may never be able to repay, prolonging the damage to their credit scores and diverting money they could use to support themselves in retirement. Or they can recognize an impossible situation, deal with it and move on.
If you can pay your bills, obviously you should. If you’re struggling, check out your options for debt relief. But bankruptcy may be the best option if your consumer debt — the kinds listed above that can be erased — equals more than half your income, or if it would take you five or more years to pay off that debt even with extreme austerity measures.
Here’s what you need to know:
You need a bankruptcy attorney: It’s easy to make a mistake in the complicated paperwork, and an error could cause your case to be dismissed. If that happens, you end up with no relief — but still, have credit scores tanked by the bankruptcy filing.
Attorneys typically want to be paid upfront: There are some legal aid and pro bono services available, but they’re often overwhelmed by demand. If you’re really strapped, call the bankruptcy court in your area to find out what resources are available. Your local bar association may be able to direct you to attorneys willing to take on some pro bono cases. Otherwise, you’ll need to scrape up some cash.
Raise cash the smart way: Trim unnecessary expenses, if you still have any. Sell stuff, if you’ve got anything to sell. If you’re still paying your credit cards and other consumer debt, you could stop and redirect the money to pay for an attorney. Another option is to borrow from friends and family. Don’t open new credit accounts to borrow the money, though, since that could be considered fraud. Working a second job can be problematic if you boost your income above the median for your area since that complicates your filing. Discuss your options with an attorney; many offer a free or low-cost initial consultation.
Don’t wait too long: There’s a misconception that people file bankruptcy at the drop of a hat or when they still have other options. The reality for most is quite different. Some drain assets, such as their retirement accounts, that could have been protected from creditors in bankruptcy. People throw good money after bad until they have no money left to seek relief.
That’s why we advise debtors in over their heads to investigate bankruptcy first.
“The worst thing that can happen is not being able to go bankrupt and not being able to pay,” Nosal says. “That’s when people really suffer.”
This information was obtained through NerdWallet and Liz Weston is a columnist at NerdWallet.