Bankruptcy Pros and Cons: Don’t Declare Until You Read This

If debt is taking over your life, it can be difficult to see a way out. Maybe you don't know how to handle your debt, so you aren’t making progress. Or maybe you’re just in over your head and need a way out. You might be considering bankruptcy.

Filing for bankruptcy can be an overwhelming choice when you’re drowning in debt. It may sound like a good idea to start over if you're losing sleep over money, but bankruptcy comes with big repercussions. That's why it's essential to weigh the pros and cons of filing for bankruptcy first.

Pros and cons of bankruptcy

How does filing for bankruptcy work?

Individual bankruptcy laws have been in place for nearly 150 years. These federal laws are designed to give a second chance to individuals who've struggled financially and can't find how to pay off debt.

There are laws in place that also offer bankruptcy protection to large and small businesses as well. For instance, you may see a business or a partnership file Chapter 11 bankruptcy, also known as reorganization.

Typically, personal bankruptcy cases begin when an individual or couple worries about or experiences insolvency and files a bankruptcy petition in bankruptcy court on their own or with the help of a bankruptcy lawyer. All U.S. bankruptcy cases go through federal courts, and once you file bankruptcy, you'll receive an automatic stay which prevents collectors from attempting to collect debts owed.

Once bankruptcy cases are filed in United States courts, bankruptcy judges then review those cases and determine if debts should be discharged.

Depending on the type of bankruptcy you file, your bankruptcy proceedings may be slightly different. But no matter which type you file, you'll likely be required to get credit counseling and debtor education through a licensed credit repair company before a bankruptcy judge discharges your debt.

Bankruptcy Chapter 7 vs. Chapter 11 vs. Chapter 13

When you're learning about bankruptcy basics, you may come across the three common types of personal bankruptcy filings, which are typically categorized by chapters under the United States bankruptcy code.

If you opt to file bankruptcy, you'll likely file for either Chapter 7 or Chapter 13 since they're the most common types of bankruptcy. If you're filing bankruptcy for your business, you may file for Chapter 11.

	Chapter 7	Chapter 11	Chapter 13
Who can file?	Individuals Businesses	Individuals Businesses	Individuals
Eligibility requirements	Must pass a means test to determine if their income is low enough to qualify	No specific debt limit No specific income requirements	Debt must be within certain limits Must have regular income
Asset liquidation	Non-exempt property may be liquidated to pay creditors	May involve selling assets while remaining in control of the business and continuing operations while restructuring finances	No asset liquidation while paying creditors over a period of 3-5 years
Debt repayment	Debts are typically discharged within a few months	Debts are typically restructured and paid off over several years	Debts are typically repaid over a period of 3-5 years
Advantages	Can be fast and relatively simple You can discharge most or all of your debts	You can restructure your finances while continuing to operate the business	You can repay your debts over time without liquidating assets Doesn’t involve asset liquidation
Disadvantages	Non-exempt assets may be liquidated Must pass a means test	Expensive and complex Must negotiate with creditors and submit a reorganization plan	Requires regular income and repayment of debts over several years Requires coming up with a repayment pla

Chapter 7 bankruptcy

Non-exempt assets of Chapter 7 bankruptcy filers are sold off by a U.S. court-appointed bankruptcy trustee to pay their outstanding debts.

Most of what you own — with some exceptions, like your home and car — can be seized to pay off your debt, which is one of the cons of Chapter 7 bankruptcy. Non-exempt assets could include real estate that isn't your primary residence, investments not in retirement accounts, and valuable artwork or jewelry.

Chapter 7 is sometimes referred to as “liquidation bankruptcy” because property not protected by bankruptcy exemptions is liquidated to pay back the money you owe. But Chapter 7 also requires applicants to prove they have a very low income. If you don’t meet the eligibility for Chapter 7, you may not be able to file it.

Chapter 11 bankruptcy

Chapter 11 bankruptcy enables businesses and individuals with large debts to reorganize their finances while continuing to operate.

As a debtor-in-possession, the debtor continues to run the company while being supervised by the bankruptcy court. The debtor must submit a reorganization plan outlining how they will reorganize their finances and business activities. The plan needs to be accepted by the court and creditors,

While Chapter 11 has a number of benefits, the procedure is difficult and expensive and often requires the help of an experienced bankruptcy lawyer.

Chapter 13 bankruptcy

Those that don’t qualify for Chapter 7 may choose to file for Chapter 13 bankruptcy instead. This bankruptcy process doesn’t liquidate your property.

Rather, this filing sets up a court-ordered payment plan, which will require that you make set monthly payments for between three and five years. After completing the repayment plan, any remaining debts may be eligible for bankruptcy discharge.

5 possible benefits of bankruptcy

Going bankrupt may feel like a negative word, but there’s some good that could come out of it. When given the chance at a new beginning, you may feel more prepared to handle your money better than you did before.

1. You could consolidate your debt (or have it discharged)

Keeping up with debt payments is hard when you can’t afford them at all. Bankruptcy can offer some debt relief by consolidating your debt into manageable payments. Sometimes your responsibility for some debt can be wiped away. The filing you select will determine this.

2. You may get to keep your property

There are some personal exemptions when you file for bankruptcy, so you could keep things like your home, car, or retirement accounts in either Chapter 7 and Chapter 13 filings. Exact exemptions depend on the state laws where you live and the value of your assets, so consult a professional if you’re not sure what property may be at risk.

While some assets may be protected in certain circumstances, it’s not guaranteed you’ll keep the rest of your property — particularly under a Chapter 7 filing. A Chapter 13 filing is usually a safer bankruptcy option if you’re a homeowner or have other major assets.

3. Chapter 7 bankruptcy can be completed quickly

The timeline for your bankruptcy completion depends on which option you file under. A Chapter 7 bankruptcy can often be completed in fewer than six months. That means you’ll be able to restart your credit journey relatively quickly. Compare this to a Chapter 13 filing, which can take years to complete the mandatory repayment plan.

4. Filing bankruptcy should put a stop to debt collection attempts

When you file for bankruptcy, creditors must stop contacting you to collect a debt. In fact, creditors aren’t allowed to contact you throughout the legal bankruptcy process — from when you file to when that debt is discharged. This means all phone calls, collection letters, and other attempts must stop.

However, not every amount you owe will be a debt that goes away when you declare bankruptcy (more on that below), so if you’re getting hounded for an outstanding debt, check to see if you’re still responsible for it.

5. You can start with a clean slate

When you’re drowning in debt and can’t see a way out, bankruptcy gives you the opportunity to start over with a clean slate. Although there are some instances where debt isn’t gone after bankruptcy, you could have most of it wiped away or reduced and paid off through a repayment plan. A fresh beginning can help you restart your financial journey on the right path.

8 downsides of bankruptcy

Bankruptcy has the potential to help you in a dire financial situation, but it can also have devastating consequences for your future. Bankruptcy should be a last resort when you’ve run through all your other options to take care of debt. If you’re considering it, make sure you know the possible blows you’ll face.

1. Your credit will tank

If you’re months (or years) late in paying outstanding debt, your credit score is probably pretty low already, but a bankruptcy filing can still cause additional harm to your score. The more accounts listed in your bankruptcy filing, the bigger the impact on your credit score. Along with that, a bankruptcy filing can stay on your credit report for seven to 10 years, depending on which chapter you file under.

2. It could be harder to borrow in the future

Having a bankruptcy mark on your credit report is like having a black cloud over your head for as long as a decade. Lenders see bankruptcy marks as a big red flag and will be hesitant to work with you. It could stop you from getting a home, car, or even a credit card in the future.

3. Not all types of debt are eligible for bankruptcy

A big misconception about bankruptcy is that if you declare it, you’re no longer responsible for paying any current debt. While filing for bankruptcy may help wipe out unsecured debt like medical bills, personal loans, or credit card debt, not all debt is eligible to include in bankruptcy filings. 

For example, student loans and secured debt like mortgages are usually still your responsibility after you file. Alimony can also not be discharged by bankruptcy. So even if you declare bankruptcy, you still may have to face outstanding debt. Depending on the debt you struggle most with, bankruptcy may not be worth it.

4. Your property might be repossessed

When you declare Chapter 7 bankruptcy, your assets are liquidated to pay off your outstanding debt. That means almost anything you own has the opportunity to get repossessed to make sure your debt gets paid. While Chapter 13 temporarily safeguards your possessions because you’re under a repayment plan, you may still face repossession if you don’t stick to the court’s orders.

5. It can be hard to qualify for

If you’re declaring Chapter 7 bankruptcy, you’ll need to prove you can’t afford to repay your debt through a means test. This test is to ensure your income is low enough to declare bankruptcy. If it isn’t, your disposable income will be evaluated to see that after your important expenses are paid (like housing and child support), you don’t have anything left over to pay for your debt. Not everyone has enough debt to file for bankruptcy.

6. It could take years to complete the process

If you successfully declare Chapter 13 bankruptcy, you could see years of paying a court-ordered repayment plan. Repayments under a Chapter 13 filing typically take anywhere from three to five years to complete.

7. Your cosigners could be on the hook

While cosigners can help you secure a loan with a lower interest rate, a line of credit, or a new credit card, these people are taking on an enormous responsibility. When you don’t pay back your loan that someone else has cosigned for, it crushes your credit score and theirs. Along with that, they’re still responsible for paying an unsecured debt that has their name on it, even when you file for bankruptcy.

8. Bankruptcy isn’t free

From filing for bankruptcy to attorney fees, you could be on the hook for hundreds or even thousands of dollars. Filing costs more than $300 for both chapters (though filing fees may be waived in some instances), and if you hire a bankruptcy attorney, you could pay thousands of dollars in legal bills. And remember, if you file for Chapter 13, you’ll have a repayment plan set up, so you’re still paying for your debt long after you declare.

7 debt types that can't be discharged

Bankruptcy allows you to eliminate or reorganize certain types of debt, depending on the type of bankruptcy you file. However, you can't get all debt types discharged by using bankruptcy. These seven debts can't be removed, regardless of the type of bankruptcy chapter you:

1. Federal student loans: In most cases, filing for bankruptcy can't discharge your federal student loan debt unless you meet highly strict criteria.
2. Child support and alimony payments: Debts related to child support and alimony payments cannot be discharged in bankruptcy. 
3. Tax debt: Certain types of taxes, such as income taxes, can be discharged in bankruptcy if they meet certain requirements, such as being more than three years old and not being assessed in the last 240 days. However, other types of taxes, such as taxes related to fraudulent filings or tax evasion, aren't dischargeable debts.
4. Criminal fines: Debts you incurred due to criminal fines through court decisions cannot be discharged in bankruptcy. This includes fines related to driving under the influence (DUI), drug offenses, and other criminal convictions.
5. Personal injury debts: In most cases, debt liabilities related to personal injury claims may not be possible to discharge through bankruptcy when the injury was caused by the debtor's intentional or reckless behavior. 
6. Debts incurred while driving under the influence: Personal liability debts related to accidents that occurred while the debtor was driving under the influence cannot be discharged in bankruptcy. 
7. Debts incurred through fraud: Debts that were incurred through fraud or other unethical behavior cannot be discharged in bankruptcy. This includes debts related to credit card fraud, embezzlement, and other types of financial fraud.

4 alternatives to filing for bankruptcy

Filing for bankruptcy is a last resort you should seek only after exhausting other potential routes. There are several alternatives you can explore that may enable you to avoid bankruptcy.

1. Consolidate your debt

Debt consolidation is the process of combining two or more debts into one. The most common debt consolidation method is using a loan to pay off all your debts to end up with this single loan to pay off.

A debt consolidation loan helps you manage your debt easier and may give you a lower interest rate than what you had on your original debt. That’s why debt consolidation loans can help you with credit card debt by potentially providing you with a lower interest rate that is easier to manage.

3. Settle your debt

Debt settlement is a process where you negotiate with a creditor or a debt collector a payment lesser than the amount you owe to settle the account. This can be a win-win outcome for you and your creditor since you eliminate your debt while your debtor gets a portion of their money.

You can attempt to settle debts you owe on a credit card or for a medical bill, as well as unsecured personal loans and private student loans. To negotiate your debt, you may either contact your debtor directly or use a debt settlement company that helps you define the terms of your debt settlement.

Learn more about debt settlement versus debt consolidation.

4. Manage your debt

Debt management is when you design a plan or use an agency to design a plan for you to pay off your debt. Debt management may also include negotiating your total debt amount, monthly payments, or interest rates.

Using a debt management agency can help you avoid bankruptcy and find ways to pay down your debt over time. However, it requires your commitment and effort to make the plan a successful one.

Debt management companies may help you with credit card, medical, and personal debts. However, most companies will first review your debt, income, and finances to confirm your eligibility for their plans.

Explore the difference between debt management versus debt settlement.

Bankruptcy FAQs

Bottom line

If you’re considering bankruptcy, you have a lot of potential negatives to consider, from the cost of filing for bankruptcy to the negative effects on your credit score. While a fresh start may sound like a good idea, bankruptcy doesn’t go away for a very long time and can seriously impact your borrowing in the future.

Bankruptcy should be a last resort, saved for when you don’t have any other choice. Explore all your other options, such as debt consolidation and budgeting changes, before you decide to file. If you feel like you have no other options, you can learn more about the different types of bankruptcy and review bankruptcy forms at USCourts.gov. Many law firms may offer free consultations, so make sure to get some legal advice before filing to get a professional view of your situation.