Should I File for Bankruptcy?

Are you in debt and unable to afford even the minimum payments? It may be time to stop fighting the inevitable and file for bankruptcy. It may feel like you’re quitting, but in truth, filing for bankruptcy can be the first step to a new financial beginning.

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You may have been pondering this question for a while now: “Should I file for bankruptcy?” Bankruptcy isn’t for everyone. But often those who need it most are too embarrassed to say, “I give” and clear their heavy financial baggage.

There is a lot of unnecessary negativity surrounding bankruptcy in society. Filers feel guilty, ashamed, and think if they just stick out their repayment they’ll eventually be able to see the light at the end of the tunnel. But that light may never shine through, and you may do more damage to your financial life than if you just took the first step to cutting the cord with your debts.

“Most people don’t want to file for bankruptcy because of the stigma associated with it, so why not reframe the situation?” asks bankruptcy expert Steve Rhode. “When you look at bankruptcy as the only legal option to eliminate your debt and get protection from your creditors, you can see it in a whole new light. There is no doubt that in most situations, filing bankruptcy is the fastest way out of debt for the least amount of money.”^[1]
The truth is, bankruptcy isn’t the end of the world. It may save your financial life. Let’s look at how and why personal bankruptcy may be your best option.

When should I file for bankruptcy?

Bankruptcy is not an easy decision to make. You can’t just file for any debt you may have accrued over time. You must prove you are unable to afford even the minimum payments on your debts with your debt to income ratio — how much money you make compared to how much debt you have.

Many people commonly think that bankruptcy is the result of someone being negligent with their finances — and just charging up what they can’t afford. That’s not true. There are many people who face one severe blow from a financial emergency and wind up with debts they can’t afford to pay back.

“Bankruptcy is ideal for people that have exhausted their efforts and they don’t have the needs to make the payments on time on their debt on a monthly basis,” says bankruptcy attorney Rabin Pournazarian. “It’s also for people that have experienced a loss of a family member or medical conditions. Or, anything else that limits their income like unemployment, disability, and loss of overtime.”

Having a medical emergency or losing a job can spiral to using credit cards to cover your medical bills or living costs while you’re out of work.

And if you’re considering withdrawing funds from your retirement accounts to pay off those debts, bankruptcy can actually save you money in the long run. The truth is you will need your retirement nest egg and removing money from it now is not a good idea. If you declare bankruptcy, retirement accounts, like a 401(k), are usually protected from creditors because they’re exempt.

“I think the ultimate decision point is when no action today is going to fix the past and will result in the financial future being worse,” Rhode says. “For example, trying to dig out of an impossible situation from past debt that robs the ability to save for retirement moving forward. The key question is if it is more important to repair the past or repair the future.”

Why should I file for bankruptcy?

It’s doubtful everyone who seeks debt forgiveness through bankruptcy shares the same reason. But if you are feeling alone in your choice, it may help to know what the common causes are.

Researchers disagree on why people file for bankruptcy, and it likely has something to do with the fact that it’s not necessary to include that information when filing a bankruptcy petition.

One widely sourced 2009 study from Harvard University points to medical debt as the main reason behind personal bankruptcy. Sixty-two percent of all bankruptcies filed in 2007 were due to medical debt, according to that study. And 92 percent of those debtors were more than $5,000 in the hole for medical expenses.^[2]
Another study from nonprofit organization the Center for Consumer Recovery concludes legal obligations to be the biggest source of bankruptcy.^[3]
Seventy-eight percent of personal bankruptcy cases are due to pressure from debt collection lawsuits, according to the CFCR. That reason was followed by 18 percent saying aggressive debt collectors drove them to file, and finally, a small 4 percent say the volume of their debt was their reason to file for personal bankruptcy.

Here are the most common reasons cited for declaring bankruptcy:

• Loss of income
• Large amount of unsecured debt like from a credit card
• Medical bills
• Divorce
• Foreclosure
• A lawsuit
• Garnished wages due to a lawsuit
• Owing taxes

Pournazarian has been practicing bankruptcy law for Price Law Group in California for more than 23 years. According to him, there are many reasons his clients have for declaring bankruptcy. But one common theme is — the bills become more than they can realistically manage.

“Typically, I see someone for whatever reason they have more debt than they can afford to pay,” Pournazarian says. “They’re not able to continue with the minimum payments. They’ve missed payments and a creditor has now begun legal proceedings against them to collect on the debt.”

Who files for bankruptcy?

You may feel your financial troubles are unique to you solely. But the truth is, many Americans declare bankruptcy every day. Over 700,000 Americans filed for bankruptcy last year alone, according to LendingTree^[4]And knowing you’re not alone can help minimize some of the anxiety you’re facing.

That previously mentioned Harvard study was co-authored by then Harvard law professor Elizabeth Warren. It revealed the demographics commonly found among bankruptcy filers. Most were well-educated homeowners with middle-income paying jobs.^[2]

A 2017 study from Census.gov backs up the findings of middle income earning individuals but gives a little more insight into the typical filer. They’re more likely to be divorced, black, middle-aged, veterans, and disabled. The age group most frequently noticed in bankruptcy cases is 30-49-year-olds. Census finds that 58 percent of bankruptcy cases are among that age group.^[5]

What happens to your credit when you file for bankruptcy?

Chapter 7 bankruptcy will generally stay on your credit report 10 years from the date you file. In most cases, Chapter 13 will show as a blemish on your report for seven years. However, there is evidence that bankruptcy filers start rebuilding credit sooner than expected, as long as the filer shows responsible credit behaviors moving forward.

Forty-three percent of people with a bankruptcy on their credit report had a credit score of 640 or higher a year after filing, a study from LendingTree reports. Within two years of filing, 65 percent had a credit score of 640 or higher.^[4]

“I remind my clients that in most cases their credit score will improve after they file bankruptcy and that they will bounce back after filing,” Pournazarian says. “So, it’s not something that will necessarily haunt them for the rest of their lives. There is a future after bankruptcy.”

But of course, all situations are different, and you should consult with professionals from a nonprofit credit counseling agency and a bankruptcy attorney to know which debt relief option is right for your situation before following through with the legal process.

Does filing for bankruptcy cost money?

Filing for bankruptcy is not free, which may seem kind of strange considering that most people who file are usually going broke.

That’s why it’s important to consult a bankruptcy expert before you file. Hiring a lawyer to file Chapter 7 will cost $1,500 to $3,000, on average nationally, and $3,000 to $4,000 for Chapter 13 filers. That is not including the filing fees which cost the following, according to the National Bankruptcy Forum.^[6]

• Chapter 7 filing fee: $335
• Chapter 13 filing fee: $310

…Your attorney’s fees can be expensive but going without a lawyer may not pan out. Bankruptcy laws vary from state to state and are tough to understand for someone with little experience in bankruptcy law, let alone someone who is not a lawyer.

Which type of bankruptcy is right for me?

There are two types of personal bankruptcies you can file. You’ll need to take a means test, which will evaluate how much you earn, own and need to pay. Before that, here’s a quick breakdown of what each entails, so you’re not caught off guard and know what to expect before meeting with a certified pre-bankruptcy counselor.

• Chapter 7 filing: This type of filing is commonly referred to as, “straight bankruptcy.” You may be able to keep certain property that you need for day-to-day life, like your home, vehicle, clothing, and even furniture in your home. But, your other type of property, which isn’t exempt from bankruptcy liquidation can be sold off by the trustee, who is a neutral third party between you (the debtor) and creditors. That nonexempt property can include any cash in bank accounts, valuable items, like a stamp or antique collection, or even musical instruments. This type usually takes six months to complete.
• Chapter 13 filing: The “repayment plan” bankruptcy. You must have a job or a regular source of income to file this type of bankruptcy. Your personal property will be protected from creditors. The process itself takes three to five years to complete, on average. And may stay on your report for seven years, but it’s possible the blemish will remain for 10 years. If you take a means test to file chapter 7 and don’t pass, you can still file chapter 13. Your debts get restructured and you’re set up with a repayment plan through the courts to settle your debts based on your current income.

How do you file for bankruptcy?

Bankruptcy can be complicated if you’re not prepared. That’s one of the reasons why you want to have a qualified lawyer helping you throughout the process. To simplify what you’ll need to do, here are 10 steps to give you an idea of what you’re going to have to do in the process of filing for bankruptcy…

Step 1: Take inventory

How much you owe. You’re going to need to show everything — every creditor you owe money to. You need the current interest rate on those debts, your current payment, and the amount you’re currently able to afford.

How much you earn. This isn’t just the money you’re receiving from your day job. If you’re getting paid from any side gigs, pensions, or even money from family members, your spouse, or roommates that helps pay the bills. Do you receive funds from the interest or dividends of investments? Include those too. You will not have to report any Social Security payments that you receive.

What do you own: Jot down all your assets. Include everything from real estate, stocks, cars, savings accounts, musical instruments, and artwork. The more comprehensive the list, the easier it will be for your bankruptcy attorney or trustee get a firm understanding of where you stand financially. Often you will have certain property that will be exempt from selling off in a chapter 7 bankruptcy case, but some states may have different laws than others.

How much you need to live: Do you rent or make mortgage payments? You must include what it costs to keep that roof over your head. Don’t leave out basic needs, like food, either. You’ll need to include the costs of your utilities and medical bills, taxes and transportation costs. Do you pay child support or alimony? If so, add it to the list.

Step 2: Pre-bankruptcy counseling

The courts want to make sure you’ve discussed all your options with a qualified pre-bankruptcy credit counseling agency. You may be recommended to try a different debt relief program, like debt management or even debt settlement before filing for bankruptcy. You must take care of this 180 days before you file.

The course itself only takes one to two hours to complete. The sessions typically cost $20-$40 or up to $100 and can be completed over the phone or internet. This is imperative to complete. If you don’t, your bankruptcy petition may be rejected.

Step 3: Get a lawyer

Bankruptcy is a debt relief option that will legally have your debts forgiven. It’s not exactly something you can look up a DIY plan to go at on your own. If you miss or make mistakes finishing paperwork, your case can be thrown out.

Step 4: File your petition

At this point, you and your attorney are ready to file paperwork and pay a bankruptcy filing fee. All the documentation you gathered while taking inventory will be used now. You will provide that to the courts. An automatic stay will go onto your accounts. That makes it so creditors can no longer try to sue you, contact you, or attempt to garnish your wages over debts anymore. Automatic stays also stop foreclosure actions if your lender has started the foreclosure process on your home.

Step 5: Bankruptcy trustee appointed

The courts want to keep this process as fair to you and your creditors as possible. By this point, they bring in a trustee to manage the process. They will review your forms and paperwork, and they will organize and put together your meeting with the creditors.

Step 6: Meeting of creditors

Your creditors have the right to question you over your debts. They don’t need to legally attend, but you and if you’re married, your spouse will need to. You need to answer whatever questions they have for you to the best of your knowledge under oath.

Step 7: Eligibility

By this point, the trustee will confirm your eligibility for bankruptcy and which chapter you are able to file.

Step 8: Payments will be arranged

If you’re filing Chapter 7, the trustee will determine what properties to sell off to pay your creditors. That can include something as simple as jewelry or as complicated as the equity in your home. If you file for Chapter 13, the trustee will set up a payment plan. You will be required to make payments, usually for a period of three to five years before your remaining balances are discharged.

Step 9: Required education

Before your debts can be officially discharged, you will be required to complete a financial education course. The goal is to provide you with the knowledge to avoid filing again in the future. The pre-bankruptcy counseling agency typically provides this course and certifies that you completed the required curriculum.

Step 10: Discharge your debts

With Chapter 7, it should take about three to six months, on average, to get to this point. For Chapter 13, you’ll need to complete the repayment plan, which can take up to five years. The debts that were found to be eligible for discharge will be forgiven. Your case will be closed after.