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What is bankruptcy and how can it help you?

Jan 22, 2024

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Written by

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Reviewed by

Key takeaways:

  • Personal bankruptcy is filed under Chapter 7 or Chapter 13 of the bankruptcy code. 

  • You might consider debt resolution instead of filing bankruptcy. 

If you're looking for solutions to debt and find yourself researching bankruptcy, know that there's no shame in that. It might be a step in just the right direction that you need. Bankruptcy can be the smartest way to deal with debt in certain situations. 

How do you know if bankruptcy is right for you? We'll walk you through the basics—as well as some alternatives—so you can feel confident in making a decision. 

Understanding bankruptcy: a simple explanation

What is bankruptcy?

  • Erase certain debts altogether, OR

  • Create a plan to pay off all or most of what you owe

Filing bankruptcy doesn't mean you've failed with your personal finances or you're not taking responsibility for your debts—it's really just the opposite. 

Choosing bankruptcy shows that you're not dodging your debts. Instead, you're going through a legal process to manage them. 

Types of bankruptcy: a quick overview

There are different types of bankruptcy you can file, called "chapters." If you're filing bankruptcy for personal debts (as opposed to business debts), you've got two options under bankruptcy laws: Chapter 7 and Chapter 13. Each serves a different purpose. 

Chapter 7 bankruptcy…

  • Lets you eliminate certain debts without repaying creditors

  • But you might have to give up some assets (items of value that you own)

Chapter 13 bankruptcy…

  • Allows you to repay your debts over three or five years

  • You don't have to give up any assets

Chapter 7 is sometimes called the "fresh start bankruptcy" because it's designed to give you a clean slate financially. Chapter 13 bankruptcy is sometimes called a “wage earner's plan,” because you pay your debts off in installments based on your income. 

Why do people file for bankruptcy?

Here are a few examples of why someone might make the financial choice to file bankruptcy to get help with their debt. 

  • Kat's son is diagnosed with a rare illness. Her insurance doesn't pay the entire cost of care, leaving her with a stack of medical bills to manage on an already tight single parent budget. She files for bankruptcy to clear those debts. 

  • Dave's marriage ends, leading to a drawn-out and expensive divorce proceeding. He has some debt and borrows more to cover divorce costs. The divorce significantly depletes his assets, leaving him unable to keep up with his payments. He files for bankruptcy to clear his debts. 

  • Ken started a business he had high hopes for, but it didn't do as well as he expected. He charged $25,000 in startup expenses to his personal credit cards to finance the venture. He was forced to close the business and can’t afford his monthly payments. He files for bankruptcy to clear his debts.

Those are just examples, and your reasons for considering bankruptcy might be completely different. The point is that bankruptcy is meant to solve a financial problem when you’re a debtor, not start a debate over whether filing is right or wrong. 

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The bankruptcy process: what to expect

Detailing how bankruptcy works takes an entire article by itself, so we'll give you the tl;dr version here. 

The basic steps go something like this:

  • Consult with a bankruptcy lawyer

  • Decide which chapter to file

  • Complete credit counseling with an approved organization

  • File a petition with the bankruptcy court

  • Attend the meeting of creditors

  • Turn over assets to the court (if filing Chapter 7)

  • Submit a payment plan to the court (if filing Chapter 13)

  • Complete debtor counseling

  • Wait for your case to be discharged

Once your bankruptcy case is complete, you get an official document from the court showing that your case has been discharged, and your creditors get a copy as well. 

Bankruptcy is a structured process, which is a good thing if you're nervous about filing. Just follow the steps laid out by the court. You have the right to file without an attorney, but getting the details wrong could cost you money. Fewer than 10% of bankruptcy filers represent themselves, and their success rate is very low. 

Consequences of bankruptcy

Bankruptcy can help you move past your debts, but there are some consequences to weigh. They center on four things:

  • Credit scores

  • Rebuilding credit

  • Loss of assets

  • Loss of disposable income

Credit scores

Does bankruptcy affect your credit? Yes, but the impact on your score depends on what it is when you start the process. 

If you're way behind on bills, for instance, then you've probably lost a lot of credit score points already. Filing bankruptcy could have a relatively mild effect. If your credit score is excellent when you file, expect it to fall sharply.

Rebuilding credit

While it can take some time to get your credit back on track after bankruptcy, it's far from impossible. Filing doesn't mean you'll never again be able to get a credit card or a loan. If you avoid new negative credit events, like late payments, collection accounts, legal judgments, and so on, your score will recover from the bankruptcy over time.  

Loss of assets

Now, what about your assets? These are items of value that you own, such as jewelry, cars, artwork, stocks, savings or investment accounts, real estate, household items, tools, equipment, or anything else that you own and could sell for money.

If you're filing Chapter 7, you may have to give up some of your assets to the bankruptcy court. The court sells those assets and uses the money to pay your creditors.

That's bad news for sure, but there's a silver lining. You're allowed to claim bankruptcy exemptions for some assets, so you don't necessarily have to give up everything. You’ll provide a list of assets to the court and they’ll tell you what you can keep. If you're filing Chapter 13 bankruptcy, you may not have to give up anything at all. 

Loss of disposable income

If you file Chapter 13, you will have to give up all of your disposable income for three years if your income is low, or five years otherwise. The court will tell you how much you have to pay each month, and the payment amount tends to be steep. 

Another thing to know about Chapter 13 is that only about half are successfully completed. There’s no guarantee that any of your debts will be forgiven. With attorney fees and court fees, it’s possible to pay more to get out of debt via Chapter 13 than you would have paid via a DIY debt payoff strategy or debt resolution

Can I get a loan after bankruptcy?

Yep, you can get a loan after bankruptcy. How soon depends on how fast your credit score bounces back. 

You might get loan offers in your mailbox right away once your case is discharged. Lenders know there's a waiting period before you can file bankruptcy again. Those lenders hope you'll become a debtor again by taking out an expensive loan with them in that period. And they might even try to convince you that you can't get a loan anywhere else, so you should be happy they're making the offer, no matter how high the interest rate is. 

But here's the truth: You're better off tuning out those offers and focusing on rebuilding your credit. At the end of the day, simple things like paying your bills on time can help you get your score moving in the right direction. It won’t be long before you qualify for better loans and credit cards, and in the meantime, you’ll have time to stabilize your finances.

Alternatives to bankruptcy

Bankruptcy isn't your only option, as you might know already if you've researched debt solutions. Here are three other possibilities for dealing with debt.

  • Credit counseling and debt management plans. Credit counseling might be all you need if you're struggling to stick to a budget or make a realistic payment plan. A debt management plan streamlines your monthly payments so you can pay off debt faster. A DMP usually requires that you commit to a high payment and give up your credit cards while you’re in the plan. 

  • Negotiating with creditors. You might try negotiating with your creditors to see if they'll cut you a break. For example, if you've got medical bills, you might ask your healthcare providers to let you pay in installments or offer a discount for cash payments. 

  • Professional debt resolution. Debt resolution could help you pay off debt for less than what you owe. A professional debt resolution company can work with your creditors to agree on the amount you pay. Debt resolution often makes better financial sense than Chapter 13 bankruptcy. 

If you're still unsure which option is right for you, talking to a debt expert can help. A debt professional can look at your budget and debts to figure out which solution might be best for your situation. 

What's next: 

  • Make a list of your debts so you can see how much you owe and to whom. 

  • Consider scheduling a free consultation with a bankruptcy attorney to discuss whether you're a good candidate. 

  • Reach out to a debt expert to explore alternatives like debt resolution.

Author Information

Rebecca-Lake.jpg

Written by

Rebecca is a senior contributing writer and debt expert. She's a Certified Educator in Personal Finance and a banking expert for Forbes Advisor. In addition to writing for online publications, Rebecca owns a personal finance website dedicated to teaching women how to take control of their money.

Jill-Cornfield.jpg

Reviewed by

Jill is a personal finance editor at Achieve. For more than 10 years, she has been writing and editing helpful content on everything that touches a person’s finances, from Medicare to retirement plan rollovers to creating a spending budget.

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