If you’re drowning in debt and having trouble keeping up with your payments while still handling your living expenses, you may have at least begun to consider filing for bankruptcy.
Bankruptcy certainly has its benefits, potentially allowing you to wipe the slate clean and start anew.
But there are a lot of things to consider before making a decision, from the negative consequences of filing to whether bankruptcy would even provide relief for your specific situation.
This is a big decision that requires a significant amount of due diligence before moving forward, and in this post we’ll go over some of the key points to help you get started.
Are You Eligible?
There are two types of bankruptcy for individuals: Chapter 7 and Chapter 13.
There are some significant differences between the two programs, but here’s a high-level summary:
- Chapter 7 allows you to completely discharge your debts, with some exceptions (such as student loans, certain tax obligations, and child support). But you may be obligated to sell some of your property to settle some of your debt obligation.
- Chapter 13 allows you to create a payment plan to repay some or all of your debts over a 3-5 year period. So your debts are not discharged, but you will also not be obligated to sell any property in order to make your payments.
Either one could be more or less beneficial depending on the specifics of your situation. But the very first question is whether you qualify for either one, and each has its own set of criteria.
Chapter 7 bankruptcy has what’s called the “means test”, which is meant to ensure that only people who truly can’t afford their debt payments are allowed to file. There are two different wants to pass it, and therefore qualify for Chapter 7 bankruptcy:
- If your monthly income is less than the median monthly income in your state for your family size, you pass. You can find current median income numbers by family size here.
- If you don’t pass #1, you’ll have to go through a complex calculation to see whether your disposable income after subtracting out certain expenses is enough to satisfy your debt obligations. At this stage it would probably be best to talk to a professional who could help you navigate the process.
Eligibility for Chapter 13 bankruptcy is a little more straightforward. Here’s how it works:
- As opposed to Chapter 7, you need to prove that your disposable income is high enough to afford a reasonable repayment plan.
- Your secured debt (mortgage, auto loan) can’t exceed $1,149,525, and your unsecured debt (credit cards, medical bills, etc.) can’t exceed $383,175.
- You must have filed both federal and state income taxes each of the last four years.
There are some other requirements for each, but those are the major ones. Assuming you qualify for at least one of them, there are a few other things to consider.
What Kinds of Assets and Liabilities Do You Have?
Depending on the specifics of your financial situation, one type of bankruptcy may be preferable to the other. Or it may be that neither would actually be particularly helpful.
As an example, neither type of bankruptcy would likely help you all that much if your primary debts are student loans. They wouldn’t be discharged in Chapter 7 bankruptcy. And while your required payments might be reduced over the 3-5 year repayment period in Chapter 13 bankruptcy, once that was over you would have to continue paying them back as usual.
The type of assets you own and their value also matters, particularly if you’re going through Chapter 7 bankruptcy. During that process your bankruptcy trustee is allowed to sell your property in order to settle your debts, but certain property is protected.
For example, your house and car are protected up to certain limits. Employer retirement accounts like 401(k)s and 403(b)s are fully protected, while IRAs are protected up to about $1 million. But other accounts, such as checking, savings, and regular investment accounts may not have the same protections.
The rules here vary by state, and having a strong understanding of which assets you might be able to keep and which you might end up losing will help you make your decision.
What Are Your Alternatives?
Bankruptcy can have the big advantage of erasing your debts and allowing you to start anew. But there are also some serious consequences, such as a hit to your credit score and a mark on your credit report for up to 10 years. So it makes sense to evaluate your other options before making a decision.
One option may be to call up your lenders and see if you negotiate a lower interest rate, a reasonable payment plan, or a settlement for a smaller amount.
You could also work on making some changes to your spending habits, cutting out certain expenses and possibly selling certain possessions to make room for your debt payments.
If you have student loans, you should look into income-driven repayment plans as a way to decrease your monthly obligation and potentially have some of your debt forgiven down the line.
You could also look into getting some 1-on-1 help from a credit counseling company. Just make sure to stick with reputable companies like The National Foundation for Credit Counseling and to avoid the late-night infomercials promising to wipe your debt away.
Make the Best Decision for You
Filing for bankruptcy is a big decision, and in the end you’re the only one who will know what’s right for you.
Do your research, evaluate all of your options, and then make the decision that most helps you reach your personal goals.
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