When you’re facing crushing debt, declaring bankruptcy can seem like a tempting option. It’s also a massive risk that can easily send you spiraling right back down into debt. Whether declaring bankruptcy improves your particular financial situation or not—and studies show that it usually doesn’t—it is always a gift to your creditors. They get to collect, while you get to scrape by on meager subsistence budget and enjoy a massive hit to your credit ratings that will follow you for 7-10 years.
What is declaring bankruptcy?
If “The Office” has taught us anything, declaring bankruptcy is as simple as shouting it out loud, and then, boom, your debt is gone.
Unfortunately for Michael Scott (and everybody), it’s not that easy, it’s not automatic, and it definitely doesn’t make your debt just go away.
In her 2011 study “The Pretend Solution: An Empirical Study of Bankruptcy Outcomes,” UC Irvine School of Law Professor Katherine Porter found that 59% of Chapter 13 filers reported having trouble paying their bills and expenses within a few months of the end of their bankruptcy, and 40% started receiving calls from debt collectors in that time. 57.5% of people said their financial situations had either remained the same or gotten worse since declaring Chapter 13 bankruptcy. As one debtor told her, "I have the same income and same debts, and now I have to refile."
Filing bankruptcy is a legal procedure—and not a simple one, most people need to hire an attorney—where the court analyzes your finances and assets and can rule that you are incapable of paying off your debt, and that your debt should therefore be restructured. It’s a common misconception that filing for bankruptcy means you’ll get it. The court could rule that your debts are not unreasonable and throw out your case, meaning you’d be out the attorney’s fees and filing fees with nothing to show for it.
There are three main forms of bankruptcy, known by their relevant chapter of the bankruptcy code:
Chapter 7: Also called “straight” bankruptcy, this is where you agree to sell your assets to pay off your debts immediately. If you missed a court date, tried to file another form of bankruptcy and got denied, or if the value of your sellable assets is less than the value of your debt, the court won’t let you file Chapter 7.
Chapter 11: Most commonly used by businesses, this version of bankruptcy has a lengthy and costly filing process. Under Chapter 11, the debtor gets to restructure their debt payments and gradually pay off their debts over several years, possibly more.
Chapter 13: This form of bankruptcy is only available to people with a stable income, so it is most commonly used by working people whose debt gets out of control. The debtor has to agree to give up basically all of their disposable income for a period of 3-5 years, and a court-appointed trustee collects that money and distributes it to the creditors.
All of these forms of bankruptcy have a couple things in common:
- The court can decide that some of your debts are simply impossible to pay and eliminate them, although there is no guarantee of that.
- While you’re under the payment terms of your bankruptcy, your creditors can’t file new lawsuits against you, they have to stop calling you, and they can’t evict/foreclose, shut off your utilities, or garnish your wages beyond what you’re already paying as part of the bankruptcy settlement.
- Declaring any of these forms of bankruptcy will create a massive black mark on your credit report that will likely bar you from receiving any new lines of credit, decent financing for a car loan, or a mortgage for at least 7 years, and up to 10.
What are the risks of filing for bankruptcy?
The first risk, as we mentioned above, is that it might not work. The court could decide that your situation isn’t severe enough to justify it. Then you’d still be stuck with all of your debt, plus the filing fees, court fees, and attorney’s fees, to say nothing of all the time and energy you put into your case. A typical bankruptcy filing can take six months, often much more. During that time, your debt wasn’t getting any better, and your creditors weren’t getting any more patient.
The major hit to your credit isn’t so much a risk as a guarantee. If you successfully file for bankruptcy, you’re going to have a very hard time getting a legitimate lender to work with you for years to come.
But the most insidious risk involved in using bankruptcy to get out of debt is that it can easily dump you right back in it. Chapter 13 leaves people with so little money to live on that a single unexpected expense can jumpstart the debt cycle right into high gear. A medical emergency, a broken pipe, a busted transmission—these are the kind of surprise expenses that lead people into debt in the first place.
Imagine that you’ve filed Chapter 13 and every cent of disposable income is taken out of your paycheck to slowly pay off your creditors. Then your car breaks down. How are you supposed to afford the repairs when you’re taking home less money than ever before? And now imagine that you’re one of the 40 million Americans who relies on their car to get to work and keep their job. You see how one bit of bad luck can quickly turn into a downward debt spiral? And while you’re struggling to keep your head above water, your hard-earned money is being funneled into the pockets of your creditors.
While your bankruptcy payment plan is in place, at least none of those creditors can come after you for more money. But the moment the grace period ends, all bets are off. If you are having extreme enough financial difficulties that bankruptcy seems like a good idea, you’re likely to continue having those difficulties while you’re on a forced austerity budget, and the consequences will be waiting for you on the other side.
A better strategy
Creditors and debt collectors may not love it when a debtor declares bankruptcy—bankruptcy filings come with delays on payments and court hassles—but they certainly don’t mind it. After all, it means they’re going to get paid.
Bankruptcy is a solution for creditors, dressed up as a solution for people with overwhelming debt. At DebtCleanse, we think any decent debt solution needs to prioritize the people whose lives are being ruined by the debt, not a giant company that intimidates people for a living.
That’s why one of the most important steps in the DebtCleanse system is this: stop paying your unaffordable debts.
It’s an extreme tactic for extreme circumstances, but as long as your creditors are getting money out of you, there’s no incentive for them to negotiate a smaller amount, or leave you alone. Missing payments will have a negative impact on your credit, but so would filing for bankruptcy. At least if you stop paying your unaffordable debt—a crucial step in our plan to get your creditors to settle for a fraction of your debt’s original value—you can stockpile that money for when you need it, rather than watching all your disposable income get siphoned away. Stockpiling whatever you can afford instead of paying it to your creditors gives you the power to pay for legal fees down the line, and in the end offer a one-time discounted lump-sum settlement to clear your debt for good.
Clearing Your Debts with DebtCleanse
Declaring bankruptcy is declaring defeat. Don’t let the debt collectors win. Fight back and stop the bleeding.
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