Filing for Consumer Bankruptcy
You have the option to discharge your debt, but it comes at a cost.
Consumer bankruptcy is usually the last strategy to deal with debts you can no longer afford to pay. It has the advantage of enabling you to legally discharge your debts, though it comes at a cost of producing a serious negative hit to your credit profile.
Whatever the benefits and costs, consumer bankruptcy is occasionally a necessary step for some consumers.
What Is Consumer Bankruptcy?
There are various types of bankruptcy, commonly referred to as “chapters”. Two apply specifically to consumers: Chapter 13 and Chapter 7 bankruptcy. Others, like Chapter 11 and Chapter 12, apply to business bankruptcies.
Chapter 13 Bankruptcy
Chapter 13 is a type of bankruptcy where you essentially restructure your debts through the bankruptcy court. A monthly payment will be determined based on your income and expenses, with the remainder going toward repayment of your creditors.
The repayment plan lasts between three and five years. At the end of that term, all debts included in the bankruptcy are legally discharged. Even if the amount of your payment plan is insufficient to cover all debts, the excess is also discharged.
Though Chapter 13 requires you to repay at least part of your debt, it's a way to protect certain assets, particularly your home.
Chapter 7 Bankruptcy
Chapter 7 represents total bankruptcy. The process is usually completed within six months, after which all debts included in your bankruptcy are legally discharged. There is no court-ordered repayment under this type of bankruptcy.
Chapter 7 is quicker and cleaner than Chapter 13, but it can result in the loss of assets. For example, if you have excess equity in your home or even your car, the court can seize those assets, liquidate them, and use the proceeds to pay your creditors.
The amount of equity you can keep (referred to as “exempt”) varies by state. Retirement plans are generally considered exempt.
In most cases, you'll file Chapter 13 if you have sufficient income to pay off a substantial portion of your debts. If you don't, particularly if you're unemployed, Chapter 7 will be the likely outcome.
Why You Might Consider Filing for Consumer Bankruptcy
Consumer bankruptcy may be necessary if you reach a point where you're either technically bankrupt – meaning your debts are well in excess of your assets – or your income is no longer sufficient to service your debts. In either situation, you'll have come to a point where your financial resources will be insufficient to cover your obligations.
It's also usually the last effort after other strategies have proven unsuccessful. For example, you may have tried debt settlement or debt consolidation, without any success. That being the case, consumer bankruptcy may be the next logical step.
The Downsides of Consumer Bankruptcy
Consumer bankruptcy may get you out of debt, but it's not necessarily a cure-all. Downsides to being aware of include:
- Your credit will take a serious hit. Depending on how high your credit score is before filing, it can fall between 100 and 200 points. A Chapter 13 bankruptcy will remain on your credit report for seven years, while Chapter 7 will stay there for 10.
- Financial activity will be limited after filing. Borrowing will be limited to subprime sources. That will make it difficult to buy a car or get a credit card. You may also have difficulty finding an apartment, and in some cases, getting a job.
- Not all debts can be discharged in bankruptcy. Some prominent examples are federal student loans, tax debts going back three years, and recently incurred debts.
- Bankruptcy may succeed in discharging your debts, but it won't affect your living expenses. If your basic cost of living is too high, bankruptcy won't fix that problem.
Alternatives to Consumer Bankruptcy
Since bankruptcy won't fix all your financial problems without cost, you may need to consider other alternatives.
Debt settlement is one of the most popular. You work with a debt settlement agency, that sets up agreements with your various creditors, to either reduce the amount you owe, have the interest removed, or lower the monthly payments. This is not a legally binding agreement, and your credit will still be impaired.
Debt consolidation is another common alternative. Sometimes by consolidating your debt into a single low-cost loan, you can better manage your obligations. But this will only work if you have sufficient income. If the loss of income is the primary problem, neither debt settlement nor debt consolidation will be an alternative.
If you're considering consumer bankruptcy, carefully weigh out the costs and what it will do to help your situation. Also, consider the alternatives. It should never be taken lightly, so plan to discuss it with a bankruptcy attorney, then carefully analyze the pros and cons.