Declaring bankruptcy is rarely anyone's first choice for addressing overwhelming financial burdens or mounting debts. However, there are some occasions when it can make sense, helping to reset your financial picture, prevent foreclosure, fend off lawsuits, and more. We asked experts to weigh in on when filing for bankruptcy might be a logical option. Here's what they had to say.
Unemployment is a challenge that millions of Americans have found themselves suddenly dealing with during the past month alone amid the coronavirus pandemic. And it's not unusual when one loses a job to ultimately end up filing bankruptcy, says Victor Fong, a licensed insolvency trustee and CPA. Resorting to bankruptcy under such circumstances makes the most sense when "you've lost your job and you have no money left over after paying your living costs such as rent, and food, to make the minimum payments on your debts and selling your assets would be insufficient to pay off all your debts," explains Fong of Fong and Partners.
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The end of a relationship can have devastating financial consequences for one or both of the parties involved. This too is a scenario under which one can file for bankruptcy, says Fong, who says it may be a logical step if "you've gone through a break-up with your partner or spouse that has decreased your household income and now you cannot make the minimum payments on your debts because you're suddenly carrying the household costs by yourself."
There are many reasons businesses tank, ranging from mismanagement to poor marketing to faulty products or services. If the business is in the red or unable to keep paying its bills, bankruptcy may help. "Even when it's due to circumstances beyond your control, such as the current COVID-19 pandemic," says Fong, bankruptcy is an option. "If your customers have stopped doing business with you and you can no longer pay your business expenses such as rent, payroll and suppliers, then you may want to consider filing," adds Fong.
Medical debts related to sickness or injury can be a tremendous financial burden and are yet another particularly timely reason why one could file bankruptcy. "If you've become ill and either you have no disability insurance or your disability payments are insufficient to pay your living costs and the minimum payments on your debts or, if you had no medical insurance, and you find yourself significantly indebted due to medical and hospital costs, bankruptcy is an option," Fong says.
This is when red lights should be flashing, says attorney Edward Hanratty, who specializes in bankruptcy. "The creditor has exhausted all of its patience to settle the debt or make a payment arrangement and is going to evict you, take the house or take your paycheck to pay off the debt. Maybe all three," he explains. Filing for bankruptcy under these circumstances can help pause evictions, foreclosures, and other legal actions.
Filing for Chapter 13 bankruptcy specifically when you're behind on mortgage payments allows consumers to make up missed payments over a three- to five-year repayment plan and prevents the property from being foreclosed upon, says attorney Richard Symmes. This form of bankruptcy, aimed at those who still have a steady stream of income, allows the debtor to keep their property and pay back debts over time via installment payments. This approach gives the debtor an opportunity to save property from foreclosure.
Declaring bankruptcy stops wage garnishment collections immediately upon filing, says Symmes. When bankruptcy is filed, an automatic stay is issued that halts any wage garnishment actions. "A consumer may be facing a writ of garnishment if they have incurred debt and have been sued for the debt and had a judgment entered against them," explains Symmes. "Filing bankruptcy stops the wage garnishment from moving forward due to the bankruptcy automatic stay and the debt would likely be discharged if it's for a general unsecured debt like a credit card."
One debt scenario not often talked about is parents filing for bankruptcy after taking on too much burden in association with their children. "Parents go into bankruptcy for co-signing loans for children," said Ash Exantus, BankMobile's director of financial education. "A parent is looking out for their child and might cosign for a car or a school loan. When the child is not able to pay that debt, the parent is left with the responsibility."
This is called robbing Peter to pay Paul, says Hanratty. "In the end both Peter and Paul get tired of it and come after you by evicting, foreclosing, seizing cars or paychecks. It can't go on," he says. Indeed, Americans carry significant levels of debt on a regular basis. According to the Federal Reserve, household debt had reached $14.5 trillion by the fourth quarter of 2019, a figure that represented the 22nd consecutive quarterly increase. As of the end of last year, total household debt was a staggering $1.5 trillion higher than the pre-recession peak of $12.68 trillion, which was achieved during the third quarter of 2008.
The stress associated with financial challenges and difficulties is very real, and it can even affect your relationships with loved ones and have a negative impact on the people in your life, says Hanratty. "If you find yourself worried all the time, afraid to answer the phone or check the mail and snapping and irritable with the people you love, it has to stop," he explains. "You get only so much life, and only so much time with the people you care about, and you're letting debt take that time, and not doing anything to reduce the debt."
If you're considering bankruptcy, it's important to understand that there are various options one can pursue. Chapter 7 bankruptcy, for instance, offers a "simple fresh start," says bankruptcy attorney Dai Rosenblum. "It's called liquidation," says Rosenblum. This version of bankruptcy is for those who have little or no disposable income. Under this approach, the debtor's nonexempt property is sold and the proceeds are used to pay creditors. Examples of property that's typically exempted from such liquidation sales include necessities needed for living and working such as motor vehicles (up to a certain value), and reasonably necessary clothing, household goods, and furnishings.
Chapter 11 and Chapter 13 are two other forms of bankruptcy and involve developing a reorganization plan that allows for developing a time frame to pay down debt. "The biggest difference between Chapter 13 and Chapter 11 is that only people, and not business entities, can file a 13 and Chapter 11 is very expensive. Accruing $30,000 in legal fees for a Chapter 11 would be considered ridiculously cheap," says Rosenblum.
Not all debt is created equal. There are several instances when bankruptcy is not an option, and student loans are typically one of them. In order to get student loans discharged through bankruptcy an individual must prove "undue hardship," which is no easy task. Individuals seeking this route must prove to the courts that you would not be able to maintain a basic standard of living if required to pay back federal student loans, and that the hardship will last for a significant percentage of your repayment period. Taxes are also among the financial obligations that cannot be done away with under bankruptcy laws. "Student loans, recent taxes, domestic obligations, all of those things are non-dischargeable," says former judge and bankruptcy attorney Ronald LeVine. These debts usually must be paid back at the end of a Chapter 7 bankruptcy, and will likely have to be paid back in full following a Chapter 13 claim. In very limited cases, federal taxes that are at least 3 years old can be wiped out under Chapter 7.
You'll also want to keep in mind that bankruptcy has a substantial impact on your personal credit, particularly because it stays on your credit report for 10 years, says Exantus of BankMobile. "But the good news is that after four years, many creditors and credit card companies will begin to start looking at your credit activity and start extending potential credit," Exantus explains, adding that you can also start working to establish new credit after some time has passed by obtaining a secured credit card, which is a credit card designed for people who may have limited or damaged credit. Such cards typically require the user to provide the issuer with a refundable security deposit, which is held as collateral. "While establishing a secured credit card, make sure that you stay below 30 percent usage on that credit card so that when creditors are ready to start lending to you again, your score is the highest it could be," says Exantus.
If your financial situation has become untenable and you're contemplating bankruptcy, here's a good barometer to help decide whether it's a logical move for you, says Ethan Taub, CEO of the websites Creditry and also Billry. "There are three points to consider when thinking about whether bankruptcy might be the right thing for you: when you can't see any way to pay your debts, you don't believe your situation will get any better soon, and you don't have any valuable items or own your own home that you could sell first," explains Taub, who suggests that if you have assets to your name, try selling those before filing for bankruptcy to help clear up your situation. "Bankruptcy is a serious thing, some items can be bought back, but bankruptcy can last a really long time. You also have to think about your profession, some careers that have a membership may not be able to work with you if you file for bankruptcy, so check on this too," says Taub.