What is bankruptcy and how can you avoid it?


If your debts have become unmanageable and you think there is no other way out, you may be wondering if bankruptcy is your next logical step. While it is true that no one wants to leave their financial fate in the hands of the courts, there are times when bankruptcy may be the only solution.

a person sitting at a table using a laptop: a woman is working while looking at a tablet

© Arthur Kochiev / Shutterstock
The woman is working while looking at the tablet

What is bankruptcy?

Bankruptcy is a formal legal process that can help consumers pay off some of their debts or reorganize their debts so that they can be reasonably paid off. Different types of bankruptcies can lead to different results, and unique types of bankruptcy are aimed at different types of consumers as well.


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Most consumers who file for bankruptcy do so with the help of a bankruptcy lawyer. In all cases, bankruptcy begins when a debtor files an application for bankruptcy with a bankruptcy court. Individuals can file for bankruptcy on their own and couples can file for bankruptcy together. Companies can file for bankruptcy using their own separate processes.

What are the types of bankruptcy?

There are two main types of bankruptcies for consumers to consider, each of which may have meaning depending on the consumer’s financial situation.

Chapter 7 Bankruptcy

With Chapter 7 bankruptcy, the property is sold and the proceeds are used to pay off debts. This type of bankruptcy is usually pursued by consumers who are not making enough money to pay off their debts.

Chapter 13 Bankruptcy

With a Chapter 13 bankruptcy, some unsecured debt can be canceled. However, the remaining debts are reorganized and put in place to be repaid over a fixed period (usually three to five years). This type of bankruptcy is often used by consumers who are earning enough to pay off their debts but need help and a fresh start.

How Bankruptcy Works

How your bankruptcy unfolds depends on the type of bankruptcy you are filing. With Chapter 7 bankruptcy, for example, a trustee is usually appointed to take over your property and appraise it for resale. The valuable assets you own can and will be sold to raise funds for your creditors. That being said, you may be able to keep important personal items and potentially even real estate, as the rules regarding your Chapter 7 bankruptcy vary depending on where you live.

In contrast, you usually keep your property when you file for Chapter 13 bankruptcy. However, you must earn regular income and agree to pay off most of your debts according to a court-approved repayment plan. A trustee will work with you to collect the payments, which he will use to pay off your creditors according to the plan.

While bankruptcy can be a relief for consumers who are able to pay off some of their debts, not all debts can be discharged. Most tax debts cannot be discharged in bankruptcy. You also generally cannot meet child support payments, alimony, most types of student loans, court fines, criminal damages, and amounts owed due to personal injury caused by the. driving under the influence.

Why would anyone go bankrupt

Filing for bankruptcy is generally considered a last resort, mainly because of the lasting impact that filing can have on your finances. A recent bankruptcy can easily bring down your credit rating, which will likely make it difficult to buy a home, buy a car, or qualify for other types of loans. Filing for bankruptcy can also increase your insurance premiums.

However, consumers who file for bankruptcy usually do so because they are unable to come out of a financial crisis on their own. Although bankruptcy is a permanent and drastic decision with many drawbacks, the process is aimed at putting people on a sustainable path to better finances. Since debts can be fully discharged throughout the process, filing for bankruptcy can be seen as a boon for those who are really in trouble and have little or no other options to consider.

How do I know if I should declare bankruptcy?

If you are overwhelmed with your financial situation and things only seem to get worse every month, you may want to consider bankruptcy as a solution. There are many situations where it makes sense to file for bankruptcy despite the consequences.

Here are some reasons to consider filing:

  • You have so much debt that it would be impossible to pay it off in your lifetime.
  • You have suffered an extreme loss of income which makes it impossible to pay off your debts without any help.
  • You have been sued for an extraordinary amount of money that you cannot pay back.
  • Your financial situation is dire and you need a fresh start.
  • Collection agencies and creditors call you around the clock and you need help from a third party.

Does bankruptcy affect my credit?

Having bankruptcy on your credit report will have a negative impact on your credit. Bankruptcy will make it harder to get loans or credits in the future, and your rates will be higher. The length of time that a bankruptcy stays on your credit report depends on the type of bankruptcy you are filing.

Chapter 7 bankruptcy can stay on your credit reports for 10 years, while Chapter 13 bankruptcy only stays on your reports for seven years. However, the impact on your credit score will decrease over time. For example, a bankruptcy filed last year will have a greater impact than a bankruptcy filed five years ago.

Bankruptcy during COVID

The COVID-19 Bankruptcy Relief Extension Act of 2021 was signed by President Biden on March 27, 2021. It extended most of the provisions of the COVID-19 Bankruptcy Relief Act until March 2022.

Some of the important bankruptcy-related provisions are that COVID-related stimulus checks are not considered income for bankruptcy purposes. Additionally, people going through the Chapter 13 bankruptcy process can now change their repayment plans if they experience financial hardship due to COVID-19.

Tips to avoid declaring bankruptcy

Bankruptcy is intended as a last resort for people who have debts that they cannot repay by other means. This is one of the reasons the credit penalty is so severe – if you can avoid bankruptcy, it’s usually in your best interest to do so. Here are some tips to avoid declaring bankruptcy.

The first tip is to try to cut your expenses as much as possible. If you are not able to balance your budget so that your income exceeds your expenses, you may find that bankruptcy does not give you the right start that you are looking for. You can also try negotiating with your creditors to see if they will agree to another payment plan.

Depending on the types and amounts of your debt, you might also want to consider debt consolidation. You may be able to consolidate your debt by applying for a personal loan and using the proceeds to pay off your other debts. You can also work with a company that specializes in debt consolidation. If you are working with a business, find one that has positive reviews and doesn’t charge excessive fees.

Next steps

If you’re not sure which move to do next, you might want to spend some time comparing all of your options. Learn about the types of bankruptcy, what it takes to file, and review any bankruptcy alternatives you might be looking for instead, along with their pros and cons.

A credit counselor can also help you determine how bad your financial situation is and whether you could potentially reorganize your finances on your own. At the very least, a highly qualified credit counselor could help you get a different perspective on your situation and determine if bankruptcy is right for you. Many bankruptcy lawyers offer free consultation to help you determine your next best steps.

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