Should personal bankruptcy be a last resort?
Only three of our experts used the term “last resort” when talking about bankruptcy, and there are reasons why it gets that label.
Yes, it will be listed on your credit report. Chapter 7 is one of the longest-lasting penalties you can incur since it sticks around for ten years rather than seven. And yes, if you have assets that don’t qualify for an exemption, there’s the potential you could lose them.
However, the reality is that people who file tend to enjoy a faster credit score recovery than those who muddle along. In addition, only about 4% of people who file for personal bankruptcy end up losing assets.
Last resort shouldn’t mean the last option considered
Steve Rhode, the Get out of Debt Guy and someone who has filed for bankruptcy himself thinks the “last resort” label is misleading and can be detrimental.
According to Rhode, “There is no first or last, just options. People should look at all their logical options, get the facts, do the math, and then make a decision about what is right for them and their specific situation.”
In this sense, if you’re having trouble with your finances, lay all your options on the table:
Waiting and hoping won’t get you anywhere
Leslie Tayne of Tayne Law Group agrees that emotions need to be taken out of the equation. But that once you realize you’re struggling, it’s time to start researching your options.
“It’s common to wait and hope things will change or hope for some event to occur that would turn the financial situation around, which ends up not happening, and then more debt accumulates,” she explains. “Educate yourself early and find out what options are available for you that make sense for your personal financial needs and not those of others.”
Overcoming the negative emotions that can come with filing
Another important thing to keep in mind is that for many, filing bankruptcy is simply the best option on the table. If you’ve been forced into an impossible financial situation by circumstances that are beyond your control, then feelings of failure are misplaced and may be keeping you from making the right choice for your future.
What happens when I declare bankruptcy?
Once your case is filed with the court, an automatic stay will be issued. This will stop any collection actions and legal actions against you, including foreclosure. You can learn more about the process in Debt.com’s Guide on How to File Bankruptcy.
One concern people often have is that they will be trapped by filing.
- What if I need to move after I filed?
- What if I need to get a car?
The reality is that consumers can be going through bankruptcy and still find a new place to live or new transportation, assuming it’s necessary.
“There are companies that specialize in working with people in bankruptcy,” Van Horn explains. “Just be sure to get the court’s permission.”
Finding a new place to live during bankruptcy
While you can’t expect to qualify for a mortgage and buy a home while you file for bankruptcy, renting may be easier than you think.
“Filing for bankruptcy makes it more of a challenge to rent, but not impossible,” Leslie Tayne explains. She advises that while many apartment complexes may turn renters down solely based on their credit report, there are other options.
“Individual landlords are a safer bet and might be more willing to work with individuals that have filed for bankruptcy. You might need a cosigner or a bigger security deposit to secure housing with a bankruptcy ongoing or discharged and reported on your credit.”
Mark Scribner advises that there are typically other factors that are more important to landlords – namely, your rental history and a verifiable source of income.
Getting a car during bankruptcy
“Vehicle financing is still available with court approval, although the interest rates are generally not favorable,” Chris Barski advises.
There are used car dealers that specifically work with people who have bad credit or filed bankruptcy. Just be sure to carefully evaluate the cost of borrowing. Make sure you understand how a higher interest rate will affect your monthly payments and the total cost to purchase a vehicle.
However, some experts say that you need to consider other options.
“You might just have to do what the rest of us did after a financial crisis,” Steve Rhode explains, “You buy a beater car for cash. It’s not your dream car, but a crappy $2,000 car can get you back and forth to work. It’s just not a fancy ride.”
The experts at WealthFit.com also say there are other options. For instance, if you need to move, find a place as close as possible to where you work.
“If you live near your job, you can either walk or use public transportation. If you need a ride somewhere, for example, a doctor’s office, you can use ride-sharing. And if you need a car for a day, you can do so for as little as $30 per day on Turo.”
Which do I file? Chapter 7, Chapter 11, or Chapter 13
Most consumers choosing which type of personal bankruptcy to file will look at two options – Chapter 7 and Chapter 13.
- Chapter 7 is the quicker option of the two. It generally takes about 90-120 days to complete. Your assets are liquidated or sold and the proceeds are used to pay your creditors off. However, many assets may be exempt from liquidation – even a home or car below a certain value can be saved. In fact, only about 4% of people who file chapter 7 have any assets liquidated.
- Chapter 13 is called wage earner’s bankruptcy because it sets up a three- to five-year repayment plan. You must make monthly payments that get distributed to your creditors to pay back a percentage of what you owe. Once you complete the repayment plan the remaining balances will be discharged.
Although individuals can also file for Chapter 11, it’s highly uncommon and mostly meant for businesses. Individuals only qualify for Chapter 11 if their personal asset totals are too high to file Chapter 7 or 13.
Of course, there are some considerations that you may need to take into account, based on your situation. Talking to a qualified bankruptcy attorney is extremely beneficial because the types of debt you have, your income, and the value of your assets will all come into play when choosing the best chapter to file.
“Chapter 13, for example, may be best if you want to save your home,” Mark Scribner explains. While many homes may qualify for an exemption, a primary residence with a high property value or a vacation home would not.
Another important consideration when filing is timing. When you file can affect your ability to discharge certain debts, such as recent credit card purchases and federal income taxes. Deciding when to file can be complex, so again a qualified personal bankruptcy attorney is your best resource.
Should you be worried about the stigma?
Another reason people avoid filing is largely psychological. They worry about the stigma of filing – what will happen if and when people know they declared bankruptcy.
“About 15% of my intakes involve some form of moral aversion to the bankruptcy process which has to be addressed,” says Chris Barski. “I am aware of the stigma some people attribute to bankruptcy, but it is not generally warranted.”
Chad Van Horn also argues that while there may have been a stigma with filing in the past, it’s been erased by economic events over the past decade.
“I believe that the stigma almost was gone after the housing bubble burst in 2008 but now it will be completely gone after COVID,” he explains.
Credit after Chapter 7 and Chapter 13
The seven- to ten-year credit penalty is one of the top reasons people avoid filing. Bankruptcy will be noted in the public records section of your credit report. Chapter 7 is noted for seven years and Chapter 13 for ten. With both chapters, any accounts included in your bankruptcy will be removed from your report after seven years.
While this may sound significant, our experts argue that the damage is not as severe in the long-term as people usually think.
Mark Scribner of oXYGen Financial points to a FICO study of consumer scores before and after a bankruptcy filing.
- Before filing, the median score was in the 550s, and scores rose into the 560s immediately after filing
- Two years after filing 28% of filers had scores above 620
- Four years after 48% had scores above 620
A 620 credit score is high enough to qualify for a traditional fixed-rate mortgage with many lenders. Even when your score is in the 500s, it’s still possible to qualify for an FHA loan.
Steve Rhode also points to two Federal Reserve studies. One that found people who file for bankruptcy have a faster rate of credit recovery than those who don’t. Another found that filers’ scores rose dramatically, long before the bankruptcy notation was removed from their reports.
Rebuilding your credit quickly after bankruptcy
There are plenty of techniques that a filer can use to start improving their score long before the bankruptcy notation drops off their credit report. Leslie Tayne explains that even some debts that you keep through the bankruptcy process offer a means to start rebuilding your credit immediately.
You can also build a positive credit history by keeping up with payments on any debts that weren’t discharged during bankruptcy. For example, if you still have student loans to repay after discharge, then making those payments on time will help rebuild your credit.
Another popular recommendation among our experts was to find someone who would be willing to make you an authorized user on a credit card. Many credit card companies report the credit history of an account on any authorized user’s history. As long as the payments on the account are made on time, it can help your credit.
There are also secured credit cards, which only require a small cash deposit to open the account. You can qualify for these cards regardless of your credit score.
“Make small purchases and pay the balance off every month,” Erik Clark explains, “and if you have a new personal loan, or an existing mortgage or car loan, make sure all the payments are made on time.”
Also, make sure to repair your credit. Enlisting a credit repair service can help you ensure that bankruptcy notations and accounts are removed from your report on time.
“You might consider services where they monitor your credit report, initiate challenges, and make sure negative items fall off at the correct time,” explains Mark Scribner.