When you have so much debt that it seems like you’ll never pay it off, bankruptcy can seem like your best or only option. What happens to your debts after you file for bankruptcy depends on the type of bankruptcy you file.
With a Chapter 7 bankruptcy, your assets get liquidated (sold) and the proceeds pay off your creditors. With a Chapter 13 bankruptcy, you work out a repayment plan with your creditors.
While bankruptcy can help you get a fresh start, it’s not the right option for everyone with a lot of debt. There are other, less drastic ways to get out of debt that don’t carry all the same consequences.
Before you start the personal bankruptcy process, consider some of the reasons why it might not be the right option for you.
Reasons to Avoid Filing Bankruptcy
Although filing bankruptcy can wipe out some debts or allow you to make minimum payments on others, it’s not necessarily a cure-all. It can have a lasting effect on your financial situation and personal life. The consequences of bankruptcy might make your situation worse, not better.
1. It Might Not Wipe Out All of Your Debts
Bankruptcy can give you a clean(ish) slate if you have a lot of credit card debt or other types of consumer debts, such as personal loans or unsecured debts. But there are some types of debt that bankruptcy won’t do away with.
Federal student loans are notorious for being pretty much bankruptcy-proof, for example. If much of your debt is in the form of student loans, filing for bankruptcy might not help you escape it.
It can be worth pointing out that if you’re able to prove to the bankruptcy court that continuing to pay your federal student loans would create an “undue hardship on you,” the court might discharge them, according to the Federal Student Aid office. That hardship needs to exist now and needs to persist for the foreseeable future for the court to agree to a discharge.
While student loan debt might be the best-known type of debt that doesn’t (usually) get discharged after a bankruptcy, it’s far from the only form of debt that’s bankruptcy-proof. Other debts that can stick around, according to the U.S. Courts, include:
- Tax liens and other tax debts
- Unpaid child support and alimony
- Debts for death or injury caused by the use of a motor vehicle while the debtor was intoxicated
- Debts for willful and malicious injury
- Debts on condo or co-op fees
- Debts on certain tax-advantaged retirement plans
Additionally, your creditors might be able to ask the court to prevent the discharge of certain debts not included in the list above. And, if you want to keep your home or your vehicle after bankruptcy, you’ll need to get and stay current on any loans you have on them.
2. It Will Drop Your Credit Score
One of the factors that have the biggest impact on your credit score is your payment history. If you pay late on one or more of your loans, your score is likely to drop. The same is true if you don’t pay your loans as agreed — for example, if you make payments below the minimum due.
When you use bankruptcy to discharge your debts, you’re effectively not paying your loans as agreed. As a result, your score is likely to drop after you file.
How much your score drops after bankruptcy depends on how good it was to begin with. People with higher credit scores are likely to see a significant decrease in their scores, according to MyFICO.
If your score wasn’t so great to begin with, it’s likely to take a somewhat smaller hit after you file bankruptcy.
The good news is that you can bring your score back up again. It might just take some time and may derail any immediate plans you had, such as applying for a mortgage or getting lower interest rates on credit cards or other loans.
Pro tip: If you need to improve your credit score, sign up for a free Experian Boost account. Experian Boost will help to instantly raise your credit score by factoring in the payment history from things like your cell phone and streaming services. Learn more about Experian Boost.
3. It Will Stay on Your Credit Report for Years
The good news is that bankruptcy isn’t for life. You can put your financial life back together and move on. The not-so-good news is that bankruptcy does tend to stick around.
The details of a Chapter 7 bankruptcy will stay on your credit report for 10 years. If you file Chapter 13, which lets you create a payment plan, the bankruptcy stays on your credit report for seven years.
Having a bankruptcy on your credit report for up to a decade can make it harder to get more credit. You might not get the best terms if you apply for a new credit card or if you want to buy a house with a mortgage. You won’t be completely locked out of credit but the offers you get might not be the best.
4. It Might Affect Your Ability to Get a Job
Another reason to try and avoid bankruptcy is that it can affect your ability to find employment in certain fields. Many employers run a pre-employment background check, which can include a credit check.
Legally, an employer can’t deny you a job because of a bankruptcy. But it can look at other information on your report, such as a history of missed payments, and use that information when making a decision. If what’s on your credit report does influence an employer’s hiring decision, they have to let you know how they came to the decision and why they made it.
Keep in mind that a potential employer can’t check your credit without you giving consent. But refusing a credit check can knock you out of the running for a job.
5. It’s Part of the Public Record
The U.S. Courts confirm that bankruptcy information does become part of the public record, meaning anyone can look it up or find out if you’ve filed for bankruptcy. That can mean a nosy relative or neighbor could find out about your bankruptcy if they take it upon themselves to do so.
It’s important to understand that someone will have to make an effort to actually look up your bankruptcy records. Although the details of your bankruptcy filing are there for anyone to see if they take an interest, it’s not as if you’ll have a giant “B” next to your name any time someone looks for you online.
6. It Can Be Expensive
Filing for bankruptcy isn’t free. Some people who might benefit from filing actually find the cost of the process is more than they can afford.
The cost of bankruptcy varies depending on a few factors, such as whether you need to hire an attorney and the type of bankruptcy you file. The filing and administrative fee to file a Chapter 7 bankruptcy is $338 while the fees for Chapter 13 are $313.
You don’t have to hire a bankruptcy lawyer, but doing so can help you present the best case and work out the best payment plan possible. The cost of a bankruptcy attorney is in addition to the filing fee. It can run anywhere from a few hundred to several thousand dollars, depending on your location and the details of your situation.
How to Avoid Bankruptcy
In many cases, the best option for avoiding bankruptcy entirely is to avoid getting into a situation where you need to even consider debt relief or getting assistance to stop the debt collection calls.
If you have some debts and are worried about getting in over your head, you can set up your finances to minimize the chance you’ll have to even consider bankruptcy.
1. Make a Budget
Budgeting paints a vivid picture of where your money is going each month. Making a budget helps you see if your expenses line up with your income or if you’re spending too much based on what you make.
You can also use the information in your budget to make decisions about your financial future, such as moving to a less expensive location or deciding to set aside more in your retirement accounts each month.
There are many ways to make a budget. I’m a fan of zero-based budgeting because it helps to break the paycheck-to-paycheck cycle and can reduce your dependence on payday loans and other types of high-interest debt. You might need to experiment with different budgeting methods to find the one that best suits you.
Pro tip: If you want a simple way to budget, sign up for Tiller. They’ll automatically pull your monthly income and expenses into a Google Sheet. This will help give you a clear view of your finances all in one place.
2. Find Ways to Make More Money
When your expenses exceed your monthly income, it’s difficult to pay off medical bills or make your monthly payment on your mortgage.
Increasing your income can help you reduce your debt and save more, giving you a financial cushion that can help you avoid having to borrow money in the future.
You have many options when it comes to boosting your income. You can start a side hustle or get a side gig, you can ask your employer for a raise, or you can find a better-paying job. Some options might be easier and more immediate than others.
For example, if you need more money now, it can be quicker to pick up part-time or contract work than it is to switch to a better-paying career. Your employer might be willing to give you a raise but it might be on their schedule, not on yours.
3. Find Ways to Cut Your Expenses
Trimming your expenses is another way to keep yourself out of bankruptcy court, especially if your loans haven’t yet become overly burdensome. When you have fewer monthly payments to worry about, you are better equipped to pay more toward your debt or to save more for future emergencies.
You can take two approaches when cutting your costs. One option is to focus on the small everyday expenses of life. These are costs such as your grocery bill, meals and drinks out, your subscription services, and little treats you buy when you’re out and about.
Individually, the small expenses don’t look significant. Will cutting out a $5 latte, a $10 bottle of nail polish or a $12 monthly subscription really make that much of a dent in your costs? On their own, not so much. But once you add up all the little things, and decide to let go of the ones you don’t use or need, you’re likely to see significant savings.
The second option is to focus on the big-ticket expenses in your life. These costs include your mortgage or housing expenses, health insurance, and transportation expenses.
While moving to a cheaper area or into a home with a lower rent or mortgage payment can help you save money over time, there is the upfront cost of finding a new place to live and moving to it to consider.
Another way to lower your housing cost is to find a roommate to share your home if you have space. You might also consider listing a room or two on a site like Airbnb or Vrbo.
To cut your transportation costs, you might consider reducing the number of cars you own or going completely car-free. Depending on where you live, you might not need a car to take care of daily errands.
If you have health insurance that costs a pretty penny each month and you don’t have a lot of out-of-pocket medical expenses, it can make sense to switch to a policy with a high deductible and lower monthly premium.
4. Sell Items
Selling items can help you avoid bankruptcy in a few ways. If you have debts that are secured by collateral, such as a car loan, selling the item connected to the loan can give you the money needed to pay off the debt.
Selling valuable possessions that aren’t tied to a loan can give you a bit of extra cash, helping you build up a cushion so you can avoid having to lean on your credit cards or other forms of debt when you have a big or unexpected expense in the future.
5. Think Twice About New Debt
It’s really easy to get into debt these days.
If you shop online, you’ve probably seen the option to “buy now and pay later” (BNPL) at checkout. BNPL programs let you purchase clothing and other consumer goods and pay in monthly installments. Although it’s promoted as a quick and easy alternative to credit cards and other payment options, it is easy to get in over your head with it.
The same is true of store credit card programs that try to lure you in with special discounts or reward points.
While these forms of debt are really easy to get, they are also really easy to get in too deep with. Your best option if you want to avoid a lot of consumer debt and the possibility of bankruptcy is to just say no.
Alternatives to Bankruptcy
Depending on your situation, making a budget, cutting your expenses, or selling certain possessions might not be enough to help you avoid debt problems.
If lenders are calling you, foreclosure is looming, or credit card companies won’t get off of your back, it can be worthwhile to consider some alternatives to bankruptcy.
1. Debt Consolidation
If you have several credit cards with a balance and a high interest rate, or if you have multiple forms of other debts, consolidating these into one loan can make sense for you. A debt consolidation loan merges several debts into one.
With debt consolidation, a lender will lend you a lump sum, which you use to pay off your other loans. Debt consolidation loans usually have a lower interest rate than each individual loan. Because you end up with just one loan, you also only have a single monthly payment to worry about.
Debt consolidation isn’t the right option for everyone who’s looking for an alternative to bankruptcy. The goal is not to eliminate your debt, but rather to make the debt more manageable and affordable by getting a single, lower-cost loan.
To do that, you need to have a high enough credit rating to qualify for a low rate. You should also have enough income to afford the new monthly payment on your debt.
If you don’t qualify for a low-interest consolidation loan, you have a few other options.
2. Debt Settlement
Debt settlement, sometimes called debt relief, can be a way to bring down your debt without going bankrupt. With debt settlement, your creditors agree to accept less than you actually owe.
Depending on how far behind you are on payments, a lender might see settling the debt as a better-than-nothing option. Lenders might also consider a reduced payment better than having you declare bankruptcy, in which case they would also risk getting nothing.
While debt relief or settlement can help you get a more affordable monthly payment and can help you dig your way out of debt, it’s not something to approach lightly. As the Federal Trade Commission warns, there are a fair number of scammy debt relief companies out there.
These companies promise to help you dig out of debt but often charge high fees or don’t fully disclose what they are going to do with your debt. Before you decide to work with a debt relief company, do your research to make sure it’s legitimate.
3. Debt Management Plan
Another debt relief option is to sign up for a debt management plan (DMP). A DMP might look similar to a debt settlement plan but there are some key differences. First, nonprofit organizations typically offer DMPs to their clients. That means that the company providing a DMP isn’t looking to earn a profit off of you.
DMPs are also usually attached to some form of credit counseling. Not only are you getting an opportunity to negotiate with your creditors and lenders and get a monthly payment that better works with your budget, you’re also improving your financial skills and knowledge.
A DMP isn’t a get-out-of-debt-free card. It can take several years before you’ve finally paid off the last of your loans when you sign up for a DMP. In the meantime, you usually won’t be allowed to take new loans, which can be beneficial if you’ve struggled with taking on too much debt but could also be limiting if you have other financial goals you’d like to achieve.
4. Changing Payment Plans
Most student loan debt won’t be discharged by bankruptcy, so if you’re primarily deep in debt because of your undergraduate or graduate degrees, bankruptcy wouldn’t do much to help you anyway.
One option that might help if you have federal student loans is to adjust your payment plan. The Department of Education has several income-driven repayment plans for student loans. Depending on how much you owe, how much you earn, and when you took out the loans, you might qualify for a significantly lower monthly payment.
There are a few things to keep in mind before you jump at the chance to change your payment plan. Depending on your income, the amount you pay toward your loans monthly might not be enough to pay off any principal or even all of the interest you owe. That can stretch how long it takes you to finally pay off the debt and make the debt more expensive.
It might be best to think of an income-driven repayment plan as a temporary measure. Use it if you’re really struggling to pay off your loans and make ends meet. But once you have a bit extra income or start earning more, shift into high gear to pay off those loans in earnest.
When you’re deep in debt, filing for bankruptcy can seem like your only option. But there are steps you can take to reduce your debt or to improve your financial situation without going broke.
Everyone’s situation is different. Before you start the process of filing for bankruptcy, consider the type of debts you have, how much you owe, and what you want your financial situation to look like in one year, five years, and 10 years.
A few adjustments to your lifestyle or a few phone calls to your creditors can be all you need to get your debts and financial situation back on track.