When, why, and why not, should I consider bankruptcy?

The idea of declaring bankruptcy, wiping out certain debts or repaying them over time with court protection—no more hassles or nasty phone calls from menacing creditors—and then moving on more-or-less debt free has undeniable appeal to anyone faced with overwhelming debt.

Should I File for Bankruptcy?

The question of whether you should file for bankruptcy is more complicated than just looking at the numbers and deciding whether bankruptcy will successfully wipe out your debts. As compelling as it may sound, bankruptcy has a lingering and far-reaching impact that touches every aspect of your life.

Bankruptcy ruins credit, makes it difficult, if not impossible, to keep bank accounts and credit cards, can cause the loss of valuable possessions, and makes it difficult to get on with necessities of life such as buying or renting a home or car, getting insurance or finding a job. In fact, most financial advisors look at bankruptcy as a desperate last resort, one that should only be carried out with the counsel of an experienced bankruptcy attorney, and only when budgeting, credit counseling or other efforts have failed.

How to File for Bankruptcy

Before you can file for bankruptcy, you must get credit counseling at your own expense from a government-approved organization (refer to this list of approved providers) within six months before you file and you must satisfy a means test to confirm that your income does not exceed a specified amount, which differs by state. Credit counseling must be completed within 180 days of filing for bankruptcy. You can find more information about means tests at the U.S. Department of Justice official website.

Next, you must decide which forms are applicable to your situation and file the proper forms with the bankruptcy court. At this point, though, you should only make decisions with the advice of an attorney. While a party without an attorney is allowed to represent themself in bankruptcy court, it is extremely difficult to do so correctly and is highly discouraged by the U.S. federal courts for the protection of the debtor.

Which Type of Bankruptcy?

The type of bankruptcy that might work in your situation is directly related to what assets and property you have and whether and how much you owe on your home, the amount of regular income you earn, and sometimes other factors. The federal Bankruptcy Code was overhauled drastically in 2005 to encourage people with a steady income to use Chapter 13 instead of Chapter 7. The following is a brief summary of the two types as they are now.

Chapter 13 allows those with a steady income to keep certain property, like a home with a mortgage or a car that might be lost during the bankruptcy process. Under Chapter 13, the court approves a repayment plan where you give up part of your future anticipated income to pay some or all of what you owe, rather than surrendering property. In return, certain debts must be repaid. These include overdue school loans, child support, taxes, car loans, and home mortgage payments and, in some cases, all of your debts.

Chapter 7 allows you to discharge, or essentially erase, almost all of your debts. A trustee is appointed to collect non-exempt property, sell it, and dole out the proceeds to your creditors. This is not an absolute solution: certain debts, among them past due child and spousal support, may not be excused; you risk losing your property; and, if you had transferred property to avoid the loss, some transfers can be undone. Unlike Chapter 13, there is no filing of a repayment plan with the court.

Chapter 7 and Chapter 13 filings are administered by someone known as a trustee. The bankruptcy trustee, appointed by the U.S. Department of Justice, investigates the financial affairs of each debtor, can sell non-exempt assets, and convenes a “meeting of creditors” about a month after a case is filed. Each bankruptcy case is assigned a judge who makes rulings if called upon. Lawyers are not required, but you may want a seasoned bankruptcy lawyer to advise you about when to file and to guide you through the complex, heavy-paperwork process.

Chapter 7 usually takes about three months to complete but the case stays on your credit report for ten years. Chapter 13 lasts from three to five years, depending on your circumstances, and remains on your credit record for seven years. Before discharge of the case under either chapter, you must receive certification for a completed course in financial management from an approved counseling agency.

When Bankruptcy Isn't a Good Option

Under some circumstances, bankruptcy is not the best option. You should not file for bankruptcy if the bulk of your debts are not dischargeable. Debts that are not dischargeable include child support arrears and certain court judgments, such as those based on fraud or breach of a fiduciary duty, and certain types of tax debts.

If your debts are non-dischargeable, there is no reason to file for bankruptcy. Bankruptcy may not be the best plan if you will lose property such as your home, car, pension or insurance. These losses, coupled with the other harmful effects of bankruptcy, may make bankruptcy a bad idea in your situation. Another circumstance wherein you may consider alternatives to bankruptcy is when a cosigner will be stuck with your debt after your bankruptcy. If this is an unattractive option, bankruptcy is not advisable under certain circumstances.

Again, when and whether you should file for bankruptcy is best determined with the help of a bankruptcy attorney. An attorney will look at your assets and property and the nature and character of your debt and determine what the possible consequences might be after a bankruptcy filing. With this information, you should be able to determine whether the consequences are ones you can live with. Keep in mind that a bankruptcy attorney will generally offer some advice about whether or not you should file before requiring you to pay for his or her legal services.