When You Should Consider Bankruptcy and How to File

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Updated on Thursday, November 19, 2020

Filing for bankruptcy can be a fresh start for debtors who are struggling to keep up with their finances, but the consequences are serious. If you declare bankruptcy, you can expect a long-lasting negative impact on your credit report, and you may have to sell some of your assets to repay your creditors.

Still, filing for bankruptcy may be the best way to get out of debt and improve your financial situation depending on circumstances. Keep reading to learn when you should consider filing for bankruptcy.

What does it mean to file for bankruptcy?

Bankruptcy is a legal process through which a debtor seeks court-ordered relief for debts they cannot repay. The court may discharge the debt or order you to pay it back, depending on which chapter of bankruptcy you file:

Chapter 7 bankruptcy is known as a “liquidation bankruptcy” because the courts discharge your debts and sell off your nonexempt assets to repay your creditors. Nonexempt assets depend on the state you live in, but they may include valuables, cash, savings, investments, a second car or a vacation home.

Chapter 13 bankruptcy is known as a “wage earner’s plan” because it’s aimed toward debtors with a regular income who earn too much to file Chapter 7. In this form of bankruptcy, the courts help the debtor come up with a plan to repay all or part of their debts.

Compare the two types of bankruptcy in the table below:

Key differences between Chapters 7 and 13 bankruptcy

Chapter 7

Chapter 13

What is it?

Legal proceeding in which your debts are discharged and nonexempt assets are sold to repay creditors.

Legal proceeding that sets up a payment plan for the debtor to repay creditors.

Who is eligible?

Consumers with a household income below the median for the state in which they live, or those who pass a means test.

Consumers with a regular income. Total unsecured debts must be under $394,725, and total

secured debts must be under $1,184,200.

How long does it take?

4 months, typically

3 to 5 years

Do you keep your property?

No

Yes

How long does it stay on your credit report?

10 years

7 years

Is bankruptcy right for you?

Bankruptcy is designed to help consumers regain control of their finances. You might consider filing for bankruptcy if…

  • Your creditors are suing you for payments. Filing for bankruptcy can stop or prevent court judgments like wage garnishment.
  • Your home is in danger of foreclosure. Chapter 13 bankruptcy can help you keep a roof over your head.
  • You’re using one form of debt to repay another. If you’re using credit cards to pay credit cards with no end in sight, bankruptcy can help.

Chapter 7 and Chapter 13 bankruptcy can give you a fresh start after dealing with insurmountable debt, but there’s a reason why it’s treated as a last resort. See some of the biggest drawbacks of bankruptcy below, but keep in mind that they may not outweigh the immediate need for substantial debt relief:

Consequences of filing for bankruptcy
Credit score dropConsumers with good credit can expect a large drop in their score — around 200 points for someone in the 700 range. Consumers with many negative marks on their credit score will see a smaller drop.
May lose assetsWhen you file for Chapter 7 bankruptcy, you may have to sell some assets to repay your creditors. Debtors who file Chapter 13 bankruptcy get to keep their assets.
Can be publicPeople tend to be private when it comes to their financial situation. When you file for bankruptcy, that information is publicly available.

Questions to ask before you declare bankruptcy

If you have insurmountable debt, contact your creditors first. They may be able to enroll you in a hardship program to temporarily halt payments, lower your monthly minimum payment or eliminate any late fees, for instance.

Nonprofit credit counseling agencies may be able to negotiate with creditors on your behalf and set you up on a debt management plan. This is a fairly common alternative to bankruptcy for people who are struggling to repay their debt.

Medical debt is a common reason to file for bankruptcy, but it might not be your best option. See if you’re eligible for medical debt forgiveness through your health care provider before filing for bankruptcy for this reason.

If you own nonexempt assets or have a significant amount of money in savings, you’re liable to lose that when filing for Chapter 7 bankruptcy. Most Chapter 7 cases filed by individuals are “no asset” cases, meaning all the debtor’s assets are exempt or they don’t have assets.

You may not be able to discharge certain types of debt, such as student loans, certain tax obligations and court-ordered debts like child support and alimony.

How to file bankruptcy

Filing alone

The U.S. Courts recommend hiring a qualified attorney to deal with bankruptcy matters, but notes that it’s possible to file without one. This is called filing pro se.

To file bankruptcy without an attorney, you’ll need to familiarize yourself with the U.S. Bankruptcy Code and the Federal Rules of Bankruptcy Procedure, as well as any local bankruptcy laws in your area. In general, you’ll have a better chance filing on your own if your case is simple and you’re filing Chapter 7.

Here’s how to file bankruptcy yourself:

Step 1: Determine whether you’re eligible for Chapter 7 by filling out the relevant means test forms. If you’re not eligible, you’ll have to file Chapter 13, which is easier done with the help of a qualified attorney.

Step 2: Seek credit counseling. You’re required to enroll in a financial management course through an accredited credit counselor and fill out the relevant documents certifying your completion.

Step 3: Fill out the bankruptcy forms. These are available on the U.S. Courts website free of charge. If you’re filing as an individual or a married couple, you’ll use the forms that are numbered in the 100 series. Check your local court’s website to see what documents may be required in your area.

Step 4: File a Chapter 7 petition. From here, your case will be scheduled. The filing fee for Chapter 7 bankruptcy is $335.

Step 5: Attend a 341 meeting. During this meeting of creditors, you’ll be asked questions under oath about your financial situation.

Step 6: Meet the requirements outlined by the courts. If you’re successful, your case will be closed within a few months and your debts may be discharged.

Filing with an attorney

When you file bankruptcy through an attorney, the process is much simpler than filing yourself. You don’t have to worry about bankruptcy forms and legal codes — you’ll just have to come prepared with your financial information, such as:

  • Income information, including amount and pay frequency
  • A list of your debts and to whom you owe those debts
  • A list of all your property
  • A list of your monthly living expenses

A qualified attorney will serve as your advocate throughout the bankruptcy process. Find a bankruptcy attorney in your area through your state or local bar association.

Many bankruptcy attorneys offer free or low-cost consultations. Book consultations with a few bankruptcy attorneys so you can choose which one’s best fits your unique situation. Be sure to ask the bankruptcy attorney about their fee structure and qualifications, but also find an attorney you’re comfortable working with — you’ll be seeing a lot of them over the course of a few months.

TIP: If you can’t afford an attorney, you may qualify for free legal services. Visit the American Bar Association’s website for more details.

Alternatives to filing for bankruptcy

Debt consolidation

Keeping up with debt payments can be overwhelming, particularly for people with multiple credit cards, loans and lines of credit. If you’re struggling to repay debt and juggle more than a few bills, then you could consider debt consolidation.

Debt consolidation is when you take out a loan or credit card and use it to repay other debts, with the goal of saving money, lowering your monthly payments or paying off debt faster. For this to be successful, your new financial product should have a lower APR than what you’re currently paying on your debts. See some common ways to consolidate debt in the table below:

4 ways to consolidate debt
Balance-transfer credit card
  • Open a new credit card with a lower APR to pay off multiple credit cards.
  • Can only be used to repay credit card debt.
  • May qualify for an introductory 0% APR offer lasting as long as 20 months.
  • May have to pay a balance-transfer fee, typically 3% to 5%.
Debt consolidation loan
  • Take out a personal loan and use it to pay off multiple types of debt.
  • A lump-sum loan with a fixed APR and fixed monthly payments.
  • Can be secured or unsecured, so collateral may be required.
  • Bad-credit borrowers will have a hard time qualifying for a low APR, if they qualify at all.
Home equity loan
  • Use the equity you have in your home to pay off many types of debt.
  • A lump-sum loan with a fixed APR and fixed monthly payments.
  • Requires that you use your home as collateral, so you risk losing the roof over your head if you can’t pay.
  • Offers lower APRs than unsecured loans, typically.
401(k) loan
  • Borrow money from your own retirement account to pay off many types of debt.
  • Since you’re borrowing from yourself, you pay yourself interest.
  • Can be costly in the long run, since you’re dipping into your 401(k).
  • You may have to repay the loan quickly if you lose employment.
  • When it’s better than bankruptcy: When you can qualify for a debt consolidation product with a low APR, and you’re confident you can keep up with the new payments on your debt.

Credit counseling

Credit counseling is a financial education and debt management service that’s typically offered through a nonprofit agency. Credit counselors can teach you about personal finance and budgeting, and they can also set up a debt management plan with your creditors.

When you enter a debt management plan, a credit counselor works on your behalf to negotiate with your creditors and repay your debts over three to five years. Your credit counselor may be able to negotiate the amount of your debt and your APR, and they may be able to get fees reduced or waived as well. This type of plan may come with a startup fee and monthly cost, though these may be waived or reduced depending on your circumstances.

Pros

Cons

  • Credit counselor may be able to negotiate APR and fees.
  • You make a single monthly payment toward your debt.
  • As long as you make the payments, debt management plans are unlikely to hurt your credit.
  • Debt management plans typically come with a monthly fee.
  • This strategy only works for unsecured debts, like credit cards and unsecured loans.
  • You’ll need to make a commitment to repaying your debt that could last months or years.

If you decide to declare bankruptcy, then you’ll be required to attend pre-bankruptcy counseling with a certified credit counselor.

  • When it’s better than bankruptcy: Credit counseling won’t have the extreme effect on your finances and credit score that bankruptcy does. A debt management plan could help you avoid bankruptcy, if you’re able to keep up with the monthly payments.

Debt settlement

Debt settlement is when you hire a company to negotiate with your creditors with the goal of getting your debts reduced or eliminated. Debt settlement companies charge a service fee, but the results aren’t guaranteed. Plus, debt settlement companies charge a fee for a service that you may be able to do yourself — you can try to negotiate your own debt settlement.

Some creditors may be willing to cut a break on past-due accounts to avoid going through the expensive and lengthy process of getting a court judgment to collect your debt.

Follow these steps to negotiate your own debt settlement:

  1. Make a list of your past-due accounts and how much you owe.
  2. Determine how much you can afford to pay toward your debt.
  3. Contact your creditors, and try to negotiate your debt balance or payment agreement.
  4. Write a debt settlement letter with the details of your agreement.

Settling a debt can have a negative impact on your credit score, and this mark will remain on your credit report for seven years.

  • When it’s better than bankruptcy: Debt settlement isn’t always a successful endeavor, but it can be an alternative to bankruptcy if your creditors are willing to negotiate. It’s worthwhile to contact your creditors before you file for bankruptcy, just to see if they’ll work with you to create an alternative.

Bankruptcy FAQ

Each bankruptcy chapter has its own set of eligibility requirements. To file for Chapter 7 bankruptcy, you need to make below your state’s median income or pass a means test. To file for Chapter 13 bankruptcy, your debts must be below a certain amount.

After you file Chapter 7 bankruptcy…

  • You have to wait eight years before filing Chapter 7 again.
  • You can file Chapter 13 bankruptcy after four years.

After you file Chapter 13 bankruptcy…

  • You can file Chapter 7 or 13 bankruptcy again anytime after you’ve paid off your debts.
  • If you did not meet your Chapter 13 bankruptcy requirements, you have to wait six years before filing Chapter 7. However, you may be able to file again sooner if you paid at least 70% of your debt obligations.
  • You may be eligible to receive a discharge in a second Chapter 13 bankruptcy, if the first case was filed two years before the new one.

Filing fees are $335 for Chapter 7 bankruptcy and $310 for Chapter 13 bankruptcy. However, that’s just a portion of the cost of filing for bankruptcy. You’ll likely also have to pay attorney fees, as well as any costs associated with pulling your credit reports or tax transcripts.

Chapter 7 bankruptcy generally takes about four months to complete, while Chapter 13 bankruptcy lasts until you’ve finished your repayment plan, typically three to five years.

The most tangible effect of bankruptcy is the impact it would have on your credit score. Your score will likely see a significant drop, particularly if you’re entering bankruptcy with a good credit score. Bankruptcy stays on your credit report for seven to 10 years.

If you file Chapter 7 bankruptcy, you also risk losing nonexempt assets, such as valuable items, savings accounts, investments, a second car or a second home. These assets can be liquidated to repay your creditors.