Individuals who have racked up excessive debt are sometimes left to ponder whether or not to file for bankruptcy. There are several reasons why it might make sense to take the plunge and file for Chapter 7 bankruptcy or Chapter 13 bankruptcy. However, making the decision is not without consequences.
When Filing Makes Sense
There are a few circumstances in which filing for bankruptcy can be beneficial:
- You've Already Tried to Negotiate: Suppose that you have attempted to negotiate a repayment plan with one or more creditors, but they have not budged. They want their full payment and aren't willing to be paid out over time—and you don't have the means to make that payment. This can leave the debtor with few options other than to file for bankruptcy.
- Your Liabilities Exceed Your Assets: Another major reason why some individuals file is that they simply cannot pay their debts, and just servicing the debt exceeds the monthly income they generate. For example, consider an individual who owes $500,000 to a bank and whose monthly debt service is $4,000. If this person only has $100,000 in assets and income of $2,000 a month, there may be few other options other than to file for bankruptcy.
- You Want to Keep Your IRA: Some individuals are concerned that the money they've built up in their IRAs might be liquidated if they file for bankruptcy. However, in 2005, the Supreme Court stated that federal bankruptcy law shields individual retirement accounts from creditors, which should allow you to hang on to your IRA, despite filing for bankruptcy.
- Filing for bankruptcy protection is sometimes the best option, but it is not without consequence.
- If you have already tried to negotiate and your liabilities outnumber your assets, bankruptcy might be a practical solution to your debt problems.
- After filing for bankruptcy, your credit will be shot and you will have limited borrowing ability.
- Bankruptcies can stay on a credit report for 10 years.
The Negatives to Filing
Filing for bankruptcy is sometimes the right (or only) choice, but there are consequences. These include:
- There May Be a Personal or Mental Impact: Sometimes individuals who file for bankruptcy develop the feeling that somehow, they've lost, failed, or that they have no hope of ever turning their finances around. In short, individuals should consider their feelings about filing in advance because it could have an impact on their personal lives and relationships.
- You Won't Be Able to Borrow: Another big reason why some individuals may not want to file for bankruptcy is that it may make obtaining lines of credit extremely difficult, if not impossible, in the future. Given the extent to which many people rely on "plastic" (credit cards) to make purchases these days, it's not hard to imagine how much this could impact your spending patterns and ability to live the life you've become accustomed to.
- Your Credit Will Be Shot: Would-be bankruptcy filers also have to keep in mind that their credit reports may be impacted by a filing. In fact, as per the Fair Credit Reporting Act, credit agencies can report a bankruptcy for up to 10 years. This can affect your ability to get a loan and can even have an impact on your career, as employers may conduct a background check during the employment screening process.
What to Expect During and After
If you do file for bankruptcy, be certain to request a copy of your credit report from the major agencies—Equifax, Experian or TransUnion—before and after a bankruptcy to make sure that all information is accurate. If not, request that that the incorrect information be changed to reflect what actually occurred.
Bankruptcies are also a matter of public record. Anyone can request to see a copy of the filing. This too should be considered, particularly by those interested in keeping their finances and personal matters private and out of the public domain.
Chapter 7 bankruptcy stays on a credit report for up to 10 years, while a chapter 13 bankruptcy (which requires a partial payment of debt) is on the credit history for seven years.
Another issue is that banks may be more reluctant to make unsecured loans for items such as a car, a home, an investment, or a new business. In order to compensate lending institutions for what they see as an increased risk, they may charge a higher interest rate on a loan, request a larger down payment, or both. Over the term of the loan, these extra costs can really add up.
No Free Lunches
Finally, there is a cost of filing for bankruptcy. Filing typically costs a couple hundred dollars, but hiring an attorney to represent you and protect your rights could cost a great deal more than that. Although individuals can act on their own behalf and an attorney may not be needed, by going it alone you run the risk of losing certain rights or property. Generally speaking, an attorney, because of their knowledge of the law and experience, is well worth the money.
The Bottom Line
Before making any decisions on bankruptcy, debtors might want to consult a credit counselor or try to negotiate with creditors to see if they can work out a payment plan. Speaking with legal counsel may also make sense. After all, every individual's situation is unique, and what might be right for one person may not be right for another. In conclusion, the decision to file for bankruptcy is not an easy one, so weigh the pros and cons carefully before signing on the dotted line.