How To

Bankruptcy A to Z: When to File and How to Recover

In the financial world, nothing evokes feelings of terror quite like the word “bankruptcy”. It’s become synonymous with a complete and utter collapse of one’s finances – a black hole that’s almost impossible to climb out of. When you declare bankruptcy, some would tell you, your life is all but over.

The reality of bankruptcy is a lot less dramatic.

Yes, it’s a major setback, but don’t forget that bankruptcy is actually a solution to a problem. People choose to file for bankruptcy because it actually improves their situation and allows them to begin mending their finances. It’s like getting major surgery – painful and exhausting, but ultimately in service of improving health and happiness.

If you’ve just filed or are considering it, know this: life after bankruptcy does exist, and it’s often a better life than you were living before.

Bankruptcy Basics

Bankruptcy is the legal dismissal of debts. Both individuals and corporations can file for bankruptcy, and there are two types of bankruptcy: Chapter 7 and Chapter 13.

Filing Chapter 7 often discharges many types of consumer loans, such as credit card debt, medical debt and personal loans. When you file for Chapter 7 bankruptcy, a trustee takes over your finances and decides how to distribute your assets to creditors.

If you have a debt secured by collateral like an auto loan or mortgage, the creditor can take possession of the property to regain their losses. If you’re current on that debt, you can ask to retain ownership and continue to make payments.

Not all of your property can be taken during a Chapter 7 filing. You can often keep your main house and car, but if you have a vacation home or a rare 1953 Corvette, you’ll probably to have give those up.

Chapter 13 is different. When you file for Chapter 13 bankruptcy, the court grants you a new debt repayment schedule, typically between three to five years. You have to earn a certain amount of money to qualify for Chapter 13 bankruptcy, which allows borrowers to retain most of their property.

Chapter 7 filings stay on your credit report for 10 years, while Chapter 13 sticks around for seven. But as time goes on, the filing becomes less and less relevant if you pay your bills on time and avoid more debt.

When is Bankruptcy a Good Idea?

Bankruptcy isn’t something to be taken lightly, as it will stay on your credit report for years. Legal fees generally cost several thousand dollars and the whole process can last several months. Sometimes, naive consumers jump to bankruptcy when it’s not the best option.

“I generally tell people if they can pay their dischargeable debts off in full in 3-5 years according to the regular terms and condition (i.e., not through collections or by going into default) and still be able to pay their regular monthly expenses, then bankruptcy may not be the right move,” said bankruptcy lawyer Jay Flesichman.

The type of debt you have also matters. Student loans or back taxes aren’t dischargeable in bankruptcy. However, if you have those types of loans and a $100,000 credit card balance, bankruptcy can relieve you of the latter so you can focus on what remains.

Lesley J. Pearson, CPA of Stronger Wallet recently helped a client file for Chapter 7 bankruptcy. He was suffering from an opioid addiction and struggling to repay consumer debt, student loans and medical bills. By filing bankruptcy, they were able to discharge $40,000 worth of medical and consumer debt.

“Doing so made a huge difference in making a plan to move forward and take care of the student loan debt,” she said.

The Effects of Bankruptcy

Bankruptcy won’t destroy your life, but it can have some repercussions you might not be aware of. Legally, your employer cannot fire you for declaring bankruptcy. However, since prospective employers may check your credit history before hiring, they can use it as a reason to not hire you.

This is especially important if you’re in a field like accounting where you have to manage company finances, or if you’re applying for a government job where workers could be bribed. In this situation, a spotty financial history could make you look like a liability.

Many landlords also run your credit before approving you as a tenant, and a bankruptcy could scare them off. If you have an apartment, stay there until it’s been a few years since your bankruptcy or your credit score is over 650. This is especially important if you’re in a city like New York or San Francisco where finding affordable housing is already difficult.

What Life After Bankruptcy Looks Like

Latoya Scott of Life and a Budget filed for bankruptcy after incurring $36,420 in credit card debt and $1,460 in medical bills. A life-long shopaholic, Scott had seen many of her family members do the same after getting into too much debt.

Fortunately, she used the opportunity to better herself and her financial situation. She kept making payments on her auto and student loans. Two years after her bankruptcy, she and her husband qualified for an FHA mortgage. Now, she has a 730 credit score even though her bankruptcy won’t fall off until next year.

“I’m quite positive that next year I’ll be in the 800 club,” she said.

Fleischman says contrary to popular opinion, life after bankruptcy is better for almost all of his clients. In fact, your credit score might improve after filing bankruptcy because your debt-to-income ratio will decrease and your collections may fall off.

Public perception of bankruptcy is also changing. A report from California State University Northridge examined the stigma of bankruptcy and “detected a noticeable shift in public attitudes” around bankruptcy, as more and more news outlets depict bankruptcy as a result of external factors and bad luck rather than irresponsible choices.

How to Recover from Bankruptcy

Fleischman says the easiest way to recover quickly after bankruptcy is to be a model consumer. Pay all your bills on time, avoid getting into more debt and create a system to stay on top of your finances.

Set up autopay for all your bills and check every month to make sure they went through. If you’re having trouble making ends meet, call your debtors and service providers as soon as possible to set up a payment plan. Remember, 35% of your credit score comes from making payments on time. As long as you do that consistently, your score will eventually improve.

If possible, consider signing up for financial literacy classes at your local library or reading about personal finance.

“Filing bankruptcy is what pushed me into learning more about finances so I could make better financial decisions in the future,” Scott said.

Consumers should also check their credit score regularly, either through a free service like Mint or directly through a credit bureau. Monitoring your credit will help you catch any negative marks that should have been disposed of during your bankruptcy.

Bankruptcy is not a death sentence. If you make responsible choices and change the patterns of behavior that landed you in debt, filing for bankruptcy will be nothing more than a short chapter in your financial story.

 

Zina Kumok is a freelance writer specializing in personal finance. A former reporter, she has covered murder trials, the Final Four and everything in between. She has been featured in Lifehacker, DailyWorth and Time. Read about how she paid off $28,000 worth of student loans in three years at Debt Free After Three.