Sunday, October 6, 2013

Is Bankruptcy the Easy Way Out of Debt?

According to the statistics provided by uscourts.gov, there were nearly 1.2 million bankruptcy filings in the last twelve months (twelve months ending in March 2013 are the most recent as of this writing). In 2012, that number was nearly 1.4 million. In a country of about 240 million adults, these filing numbers represent something like 1 out of every 200 adults in the US.
With so many people turning to bankruptcy to get out of debt, it seems like an easy "out". Let's take a look at what's involved, what the implications of a filing are, and how it compares to other debt relief options.

Is the Bankruptcy Process an Easy Out?

Going through a typical Chapter 7 bankruptcy (the most common type) involves three main steps:
  1. Filing - To initiate the bankruptcy case, you'll need to file a series of forms outlining your debts, assets, income, expenses, and related information. (For a complete list of forms, and more detail on the process, see this previous post.
  2. Court Hearing - Once you've filed the paperwork, you'll get a date for a court hearing. At the hearing the bankruptcy trustee will ask you a series of questions, mostly to confirm the information in your paperwork, and to determine how your debts and assets will be handled. For the majority of people, this meeting only lasts about five to ten minutes.
  3. Discharge - After you hearing, assuming everything goes well and there are no complications, most of your debts will be discharged, and you're now off the hook and debt free.
Now, this is a gross simplification of how a typical bankruptcy case works, but in general that's the process. The whole thing takes about three months, but there are many important legal considerations along the way, which is why most people will consult with a lawyer before moving forward with a bankruptcy case.
After the case is closed, your credit card debts, medical debts, payday loans and most other unsecured debts are gone. Secured debts, like your car loan and home loan, can also be wiped out, but if you want to keep your home and your car, you'll need to keep those debts (this is called reaffirming debt in bankruptcy) and make the payments. See this post on reaffirming car loans, and this one on your home for more information.

What Can Go Wrong?

There are a few things that make the bankruptcy decision complicated for many people. Fundamentally, there are two big potential problems.

1. You have valuable property that may be at risk.

For most people, there are two potential sources of personal equity that may be at risk in bankruptcy, cars and real estate. In a bankruptcy case, both your debts and assets are evaluated to determine if some debt could be repaid by liquidating your assets. 
The bankruptcy trustee will typically look to see if you have equity in real estate or automobiles, since these are the easiest to sell. If you own a home or a car (or both), and the value of the property is much greater than the loan you used to buy it, that property may be sold off to repay some of your creditors.
For more on how this works, and on the exemption laws that protect your property in bankruptcy, see this article on your property and equity in bankruptcy.

2. You need access to loans in the near future, so you need good credit.

The second downside to bankruptcy is its affect on your credit score. A bankruptcy on your credit report will have a serious impact on your FICO score. How much impact the bankruptcy will have depends on how good or bad your credit is when you file. If you've got great credit, expect a serious drop. If your credit is already on the low side (which is the case for most people filing bankruptcy), the effect will be less dramatic, but still significant.
In a nutshell, if you file bankruptcy, expect to have a hard time getting any new loans right away. You might be able to get a new credit card or even a car loan, but you'll have to pay very high interest rates. This will be the case for the first few years after your bankruptcy, but if you stick to a reasonable budget, and pay your bills on time, you can start to fix up your credit over time.


What Other Options Are Available?

Bankruptcy is sort of the "ultimate weapon" of debt relief, and should be used only when other options won't help. If for no other reason, you should keep a bankruptcy option last because you can only get your debts discharged through bankruptcy once every seven years (more or less, depending on certain legal issues). It's not something that's always available. You should consider asking family for help, getting a second job or another source of income, or adjusting your budget to pay off more debt each month.
If none of those are realistic options for you, then you may want to schedule a consultation with a bankruptcy lawyer. This shouldn't cost anything, and you can find out if bankruptcy will work for you. Make sure to ask the following important questions: 1. Here is my income and job situation, do I qualify for bankruptcy? 2. Here are all my debts, are they all dischargeable in bankruptcy? 3. I have this property to my name (list all the big items), is any of it unprotected or at risk? A quick consultation with a professional will give you a good idea of what bankruptcy would do, what the downsides would be, and whether you have better options.

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