The decision to declare bankruptcy is not to be taken lightly. It is often a very difficult and time-consuming process that can affect your financial standing for years after your initial filing. Yet people just like you find no other recourse but to file for protection from their creditors. Taking this drastic step is comprised of many substantial components that must be considered before entering into legal action. With so many factors involved, the uninitiated can quickly find themselves confused and unwittingly make their situation worse than need be.
Bankruptcy can be intimidating and costly, so let’s examine everything you need to know about this big step you’re about to take. The important thing to keep in mind, above all else, is that declaring bankruptcy doesn’t make you a bad person or indicate that you are irresponsible with your finances. In fact, it’s very possible that making this decision is not only necessary, but the first stage towards turning your financial situation around in a positive direction. You’re not alone, millions of people around the country are mulling over this very same quandary. Just remember, Donald Trump declared bankruptcy four times! We should all be so lucky to be in his position today and he serves as a prime example that you can and will make it through this challenging time.
Taking the First Step
In order to decide whether or not bankruptcy is the right move, you must first take stock of your current financial situation. Assess the realities of your monetary predicament through a prism of inventory, not just of your current assets but the amount you owe your creditors, too. When the first is insufficient to relieve the second, then you could be a candidate for bankruptcy.
Demonstrating a protracted routine of paying the minimum on your credit card balances and dodging repeated phone calls from a litany of collection agencies while your debt continues to mount are a few of the red flags that might indicate bankruptcy is the right move. If this sounds like your current plight and bankruptcy may apply, it often happens in one of two ways: you either declare voluntarily or, in certain cases, one or more of your creditors may file for a court order against you to compel a motion for bankruptcy.
In each instance, you’re facing a variety of bankruptcy laws that are in place to protect both your creditors and you at the same time. The former is the most common method of declaring bankruptcy and you shouldn’t go it alone. Contact a good bankruptcy attorney who can help you understand your rights and devise a strategy for your particular situation. But before you commit to this action in full, you must be cognizant of the different types of bankruptcy filing options available to you and the impact each will have on your credit score. This action should not be considered an “easy out” from your bills and debts; bankruptcies require a lot of work and will stick with you for an extended length of time.
Forms of Bankruptcies
If you’ve made the prerequisite estimations of your assets and your liabilities and you feel that you have no other choice but to go down the road of filing for bankruptcy, then you have a range of options with respect to the type of bankruptcy you wish to declare. The two most common forms of bankruptcy that most people file for are Chapter 7 and Chapter 13. Each one comes with its own pros and cons, but both options provide adequate protections from your creditors and both of them will be reflected on your credit score for a considerable length of time.
According to Experian, one of the leading credit reporting bureaus, a Chapter 7 bankruptcy is reflected on your credit report for a duration of ten years and a Chapter 13 filing is shown on your report for a duration of seven years. These will greatly impact your credit score and prove detrimental in your application for credit in the near future. For some lenders and financial institutions, a bankruptcy seen on a credit report of an applicant is a simple non-starter. They can deny your request for a loan immediately for as long as the bankruptcy remains on your report, which means you may find it very difficult to get approved for anything from a credit card to a car loan to renting an apartment.
In other cases, you may indeed get approval for some form of credit but only with extremely high fees, interest rates, and other costly components that make attaining that credit quite expensive. Therefore, you want to make the choice to file for bankruptcy very carefully and be cautious in deciding which type you wish to file for in court. The difference between the two most common bankruptcies for individuals is a reporting of three years, but the terms and conditions could be far more impactful beyond a poor credit score.
There are other forms of bankruptcy that might affect individuals in the form of Chapters 11 and 12, but these are more commonly associated with corporations, LLC’s, limited partnerships, and small businesses. The latter of the two, Chapter 12, is usually filed by farmers and commercial fishermen and it caters to the seasonal nature of their income. But for the sake of this discussion, we will focus primarily on Chapter 7 and Chapter 13 as these are the two most typical methods by which to file.
Chapter 7 Bankruptcy
Selecting Chapter 7 can come from a range of reasons and hardships. An individual may find him or herself filing for Chapter 7 if they are unexpectedly unemployed, going through a costly divorce, incurring large medical expenses, or has a credit situation that has spiraled entirely out of control. But it’s vital to know how this form of bankruptcy works before committing to it.
This method is the most straightforward and, could be considered an easier form of bankruptcy compared to Chapter 13. Chapter 7 is often referred to as a “straight bankruptcy” which requires the liquidation of all your assets, holdings, and basically anything that can be seized and liquidated into cash to pay off as much of your debt as possible. This may include all of your personal assets, including your home, your company, and anything that you hold that is determined to have value. Once the liquidation process has been completed and that money allocated to the creditors in full, then the liabilities are considered satisfied, even if the total of your liquid assets was not enough to cover the entirety of the debt. Those obligations are no longer your responsibility.
There are benefits to filing Chapter 7, the first of which being that it puts you on the road to recovery fairly quickly. You are not required to remain in the process of meeting your financial obligations through payment installments or other fiduciary commitments that come with other types of bankruptcies. Once you file for Chapter 7 and your assets have been liquidated to pay your debts, the process is over. The typical length of time required to complete the transaction is usually around four months. The case is then closed and you can start to rebuild your credit and fix your score. But once completed, the bankruptcy is on your report for ten years and it cannot be removed before that time is up.
Unfortunately, there are some caveats and restrictions that come with filing for Chapter 7. For starters, an individual may only liquidate “non-exempt” assets that he or she owns and has a right to liquidate. These items usually include family heirlooms, collectibles and collections of any value, second cars and homes, cash, bank accounts, investments, pretty much any items that are expensive and retain meaningful value.
“Exempt” assets that may still be retained by an individual in a bankruptcy case often include their motor vehicle, depending on the current Blue Book value, every day clothing (fur coats and other garments of high value may be taken), common household items and/or appliances, any tools that are inherent to the individual’s current job or profession (you still have to be able to make an income), pensions, a portion of the equity in the home, and any jewelry that falls below a certain value. All of these things may be kept by the individual even after their Chapter 7 bankruptcy has been finalized.
Some debts are not eligible to be considered for bankruptcy relief and these may still remain and continue to accrue even after the case has been closed. Mortgages and liens can not be satisfied through bankruptcy. If there are certain holdings being used to secure a loan or payments being made on an item that the individual wishes to retain, then he or she must continue making those monthly payments. In order to discharge a loan or stop making payments on that item, then the item must be forfeited or surrendered to the creditor.
There are other items that are often ineligible as well, though some may indeed qualify dependent upon a number of aspects related to the debt. In these cases, back taxes, school loans, and so-called “domestic support obligations” such as alimony and child support will not be considered for bankruptcy relief. With respect to the first two items, mitigating factors may be the age of the loan or the amount outstanding and may be re-considered in order to make them eligible for discharge.
Chapter 13 Bankruptcy
A similar scenario to Chapter 7 in that debts are discharged, this form of bankruptcy has many components that contribute to a longer process for closing a case and is better suited for individuals who want to retain more of their property and have more of an ability to pay what they owe over a set period of time. Chapter 13 is commonly referred to as a “reorganization bankruptcy” and allows for an individual to pay off the monies owed from their future income between a period of three to five years, with the maximum duration being granted in many cases.
Once a plan for reorganization is devised and approved by the court, the resulting debt amount is paid by the trustee. Any debt that still remains outside of the approved reorganization plan is considered discharged and the individual is no longer obligated to pay that outstanding portion. This method of filing is ideal for individuals who have a viable income stream from which to pay off the reorganized debt and it prevents them from having to liquidate the majority of their valuable assets.
One of the big advantages to filing Chapter 13 lies with being able to keep your belongings while still paying off just a portion of unsecured debt owed to creditors. If your reorganization plan only calls for a payment of 25% of the total assessed debt over five years time, the remaining 75% along with any applicable fees or interest, is eliminated. You may also pay that amount out of your disposable income, if suitable, so you can still keep current with bills and other payments that need to be made on a routine basis.
Considering that Chapter 7 is a much quicker method by which to have debt discharged because it uses liquid assets to satisfy as much of it as possible up front, creditors will no longer be calling and harassing you to pay what you owe. Chapter 13 cases remain open for a lengthy period of time as payments are being made towards the debt, but that does not give creditors the right to contact you at any time. In fact, once a reorganization plan has been approved by a bankruptcy court, your creditors are forbidden from continuing to contact you about your debt.
There are some terms and regulations that come with Chapter 13 with respect to the type of debt that can be included and responsibilities of the individual filing for this form bankruptcy. Mortgages and other long term, accruing loan debt must still be paid as normal and can be taken care of through the reorganization plan or free of it. However, any back monies owed can be spread over the monthly installments that are being allocated within the three to five year reorganization timetable. In many instances, an individual is able to keep their belongings and must continue to stay current with any necessary payments and maintain any insurance that is required as well.
The Impact on Credit
As we’ve discussed, bankruptcy can have a major impact on your credit score and severely limit your ability to get credit approval from future lenders, landlords, and credit card companies. When these entities see a poor credit score they already get nervous, but when they discover a bankruptcy is part of the report, it’s often not worth the risk.
It’s even worse in a struggling economy as lenders find no upside in dealing with someone who’s filed for bankruptcy even once, as the statistical likelihood of them doing so a second or third time is high. In their view, it’s almost certain they won’t ever see the money they’re owed in full, if at all. Therefore, the bankruptcy you choose to file will have a varied impact on your credit report and score. A Chapter 7 remains on your report for ten years, a Chapter 13 is there for seven and the work you’ll put in to get your score back into good or even acceptable standing could take almost as much time only after the filing is dropped from your report.
In the time you have a bankruptcy reflected on a credit report, your score will remain low or poor. It doesn’t get any easier as time passes, either, as you’ll have just as much difficulty getting approved for a new credit card in the sixth or seventh year of reporting as you will in the first or second. The score is also unaffected by your previous status once a bankruptcy is reflected on a report.
Many people believe, incorrectly, that having accounts in good standing and a higher score prior to the bankruptcy filing will be considered when determining your score after it shows up on your credit report. As far as the credit companies are concerned, they don’t care how positive your information might have been or how current you were on all of your accounts and payments, the Chapter 7 you have on there now is all that matters. All of that dedicated diligence and hard work you may have put in to keep your score high, is all irrelevant now. The current score only reflects the current status of your report and anything you can do to improve it will be accounted for from this point forward. Nothing prior is factored in.
Another thing to keep in mind is that all credit reports and bankruptcies are not the same. Your situation may be very different than someone else, both positively and negatively. It’s likely you don’t have as much debt to discharge as another person, and yet someone else may have even less than you to eliminate. Each of us files for bankruptcy for different reasons, so these influences may have a greater or lesser effect on your credit rating.
Everyone’s credit is negatively impacted with a bankruptcy filing, but not everyone will have the same uphill climb towards re-establishing a good credit score. Fluctuations such as the amount of debt owed and discharged, the number of accounts involved in a bankruptcy case, and the type of filing, be it Chapter 7 or 13, all play a role in how quickly your credit score rebounds after a bankruptcy.
Improving That Score
There are a number of things you can do to get started on rebuilding your credit after a bankruptcy. While most bankruptcies remain on your report for up to 10 years, it can take an additional 4-5 years to finally get that score back up around 700 or higher, which is where it ideally should be. Be proactive about monitoring your credit score, check for any errors, and refer to the FICO range and ratings guide to better educate yourself on scores and how they can be affected by items placed on your credit report. Then take the proper steps towards keeping a report that creditors will want to see from you and before long, your score will improve. Rebuilding your credit score starts with paying all of your accounts in full and on time.
Re-establish your credit by getting another credit card. But wait, you’re wondering how you’re going to get approved for a new card with a poor credit score. The answer lies in a secured credit card. Consider it a “pay as you go” arrangement where you give the credit company a sum of money which they count as collateral towards your use of their card. You’re still expected to make your monthly payments (and be sure that you do, and again, on time). But in the event you miss one or two or default on your bill entirely, they already have your money as collateral and they will apply it to your balance. If it sounds almost too good to be true, well, there are usually high fees that come with these cards so you’ll be paying more for the privilege of having a credit card to help your score improve.
You may also try applying for a store credit card from a retailer like Macy’s or Best Buy, where the approval requirements are usually less restrictive then a traditional credit card from a bank yet these accounts will still be considered in determining your credit score. Just don’t apply for too many. Keep only a few cards as having too much credit can be a bad thing.
Our Final Thoughts
Bankruptcy is serious. While it can alleviate the strain of high debt, it can still prove to be stressful in the long run as you work hard to reclaim your credit standing. But for some people, this is a fresh start that is desperately needed in their current situation. The process represents a lot of time and soul-searching and it takes smart planning, both before and after you file. The best solution is to try and avoid declaring bankruptcy at all, work with your creditors to pay what you owe through installments or partial forgiveness. Though at some point, your income may not be what it once was, and for whatever reason, you find yourself drowning in debt. If so, then be sure you know your rights and consider everything you’ve read here to better prepare yourself for going forward with your decision.