When to File for Bankruptcy

By Susan Landis-Steward , last updated July 11, 2011

If you have a lot of debt you can't pay and creditors are threatening you daily, bankruptcy may look attractive. A bankruptcy allows you to wipe out some debt or restructure your debt so you can pay it off over time without being hassled by creditors. It also gives you the chance to start over relatively debt-free. But bankruptcy is not a magic bullet and should not be undertaken lightly. The consequence can be long lasting and can even cause problems outside of your financial life. Bankruptcy remains on your credit report for seven to ten years, depending on which type you file, and can affect your ability to get job as well.

There are two types of personal bankruptcy, Chapter 7 and Chapter 13. In Chapter 7, the court sells your assets and uses the proceeds to pay off your debt. Chapter 13 allows you to pay your debt over a negotiated period of time and makes your creditors stop hassling you.

Bankruptcy destroys your credit and will make it very hard to get future credit or loans for cars or homes. Bankruptcy should only be used as a last resort after you tried negotiating with your creditors and sought credit counseling. In fact, you must seek credit counseling within six months of filing for bankruptcy.

Before you decide to file for bankruptcy, take a realistic look at your financial situation. Bankruptcy will not get rid of certain kinds of debt like student loans, alimony, child support, or back taxes. Look at all your debt, except for your mortgage and car payments, and see if you can put together a plan to get rid of your debt in three years. Note that you will not be able to achieve this if you continue to use credit cards and make only monthly payments. Look at the list of all your debt and note the balances and the interest rates. Cut up your credit cards, or freeze them in a block of ice, but don't close the accounts. Closing your accounts looks bad on your credit history.

If you want to avoid bankruptcy, pay all of your debts every month, giving the minimum payments to all but the debt with the highest rate. Put any additional money toward this debt and pay it off as quickly as possible. As soon as that debt is gone, do the same with the debt with the next highest interest rate. If you have to sell some of your assets to do this, do so.

If you absolutely have no choices, say because a divorce, death, job loss, or other emergency has left you destitute, you may have to file for bankruptcy. But only do so after trying everything else and after talking to a bankruptcy attorney. First, though, you should talk to a credit counselor. In fact, before you can file for bankruptcy the court usually wants you to see a credit counseling service in the six months prior to filing. A bankruptcy attorney can guide you to a reputable credit counseling service and give your further advice.

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