If history is any guide, we can expect a surge in personal bankruptcy cases in the coming months and years. In 2008, as the Great Recession took hold, annual bankruptcy filings surged almost 30% over the previous year, eventually reaching more than 1.5 million in 2010 — just about double the pre-Recession level. Since then, the number has dropped by half. But here we go again…
When all else fails, bankruptcy can be a reasonable option. It is not a decision to take lightly, but it is also not a decision that should diminish your feeling of self-worth. If you are experiencing a very serious financial crisis that you cannot resolve on your own, filing for bankruptcy may be part of the path forward.
The Real Deal
An important point often overlooked is that a bankruptcy filing cannot be used to override the rights of your lenders to whom you have pledged collateral. Stated more simply, while bankruptcy can be an effective way to extinguish unsecured debts such as credit cards or medical bills, it cannot “get rid of” a car loan or a mortgage. As well, government debts (federal student loans, some taxes) and court-ordered payments such as child support generally cannot be discharged in bankruptcy. All of which is to say that if the debt that is making you consider bankruptcy is one of these types, a bankruptcy filing may not resolve your situation. On the plus side, in most cases your retirement account assets are protected in bankruptcy.
For most individuals, the parts of the bankruptcy code that will be relevant are Chapter 7 and Chapter 13. Most personal bankruptcies happen under Chapter 7. Under a Chapter 7 (or “straight”) filing, your assets are liquidated to satisfy your creditors. But — and this is a big “but” — most of your assets are likely to be “exempt.” No one is particularly interested in taking your low-value personal possessions, or even your sports memorabilia collection unless it is very valuable. Laws vary by state, but you will usually be able to keep your home and even your car if you own them outright. But here is another “but”: as mentioned above, Chapter 7 does not extinguish the rights that your secured lenders have to their collateral. In plain English, if you file Chapter 7 bankruptcy and do not pay your mortgage or your car loan, you will lose your house or car. A Chapter 7 filing cannot stall a foreclosure on your home or repossession of your car.
On the other hand, under Chapter 13 your debts are “reorganized.” In short, you submit a plan to pay your creditors over time from your future income. An advantage is that you may be able to negotiate under Chapter 13 to get caught up on your overdue house and car payments. A key consideration when considering Chapter 13 is whether or not you can actually stick to the payment plan. If your income remains low or highly uncertain, a Chapter 13 bankruptcy may just be delaying the inevitable. If, for example, you are considering a reorganization of your debt in order to catch up on your mortgage, you need to ask yourself very honestly if you can really afford that particular home. You may be far better off just letting it go at the start.
Final Notes To Consider
Bankruptcy gets very complicated very fast and rules vary greatly between states. You will need specialized legal assistance from a lawyer practiced in bankruptcy in your state. A good place to start is the National Association of Consumer Bankruptcy Attorneys (NACBA). On average, you can expect to pay up to $1500 for a Chapter 7 bankruptcy, and more than double that for the more complicated Chapter 13 filing. A common mistake happens when a person waits until they have absolutely no cash on hand before deciding to file for bankruptcy, only to find that they cannot afford to file. Depending on your income, you may be able to use a non-profit legal aid organization to assist with a bankruptcy filing.
The consequences of filing for bankruptcy are fairly long-lasting. You can expect the filing to stay on your credit report for seven to ten years. During that time, you may be able to rebuild your credit with a secured credit card, however you will likely find it very difficult to get a home mortgage. Other kinds of secured credit — such as a car loan — will likely be available, but at an exorbitant interest rate.
A bankruptcy filing is not the end of your financial life, but it will — and perhaps should — press pause on some aspects of it for a considerable length of time. The key is how well you use this “time out” to your future advantage.