Pros and Cons of Filing Bankruptcy: What You Need to Know

If you’re in debt and can’t pay it back, obtain a loan, or don’t have anyone to borrow from, it may be time to file bankruptcy.

While it may sound like the obvious solution, there are many pros and cons of filing bankruptcy to consider before you make your decision. It’s important that you know them, and what will happen if you file.

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What are the pros and cons of filing for bankruptcy

Before making your decision, you need to be aware of the pros and cons. They’re generally about the same whether you file for Chapter 7 or Chapter 13, with one key exception:

The biggest disadvantage: Chapter 7 means test

There are two primary types of personal bankruptcy: Chapter 7 and Chapter 13. The key difference is that Chapter 7 liquidates some of your assets, and the remainder of your debts are dismissed. Chapter 13 is a repayment plan. Your bankruptcy trustee will set up monthly payments and monitor your spending.

To be eligible to file for Chapter 7, a filer must pass a means test, which determines whether the filer qualifies for financial assistance to obtain a service or goods such as welfare payments. Before making any filing decisions, you must determine whether you’ll be eligible for Chapter 7.

The purpose of the Chapter 7 means test is to narrow eligibility to those who truly can’t afford to repay their creditors. The income requirements vary by state, so you’ll need to either do some math or set up a free consultation with a bankruptcy attorney.

How to determine eligiblity

Is your current monthly income more or less than the median income in your state for your family’s size? Use this chart from the Department of Justice to figure out your state’s median income.

Pro tip: This is your gross income from the past six months multiplied by two.

If you earn less than the median, you’ll pass.

If you earn more than your state’s median income, you must move on to the next step.

Determine your monthly disposable income by deducting permissible monthly expenses from your current monthly income. You’ll likely pass the means test if you have a low disposable income.

Pro tip: Only filers with consumer debts must take the means test. Some active-duty military service members and Veterans may also not be required to take it.

Here are 13 advantages of filing for bankruptcy

The biggest pro of a bankruptcy filing is that you get a fresh start. If you’re feeling overburdened by debt, it could be the relief you need to get back on your feet. Here are the biggest benefits:

1. You are granted an automatic stay

One of the many pros of filing for bankruptcy falls Under Section 362 of the U.S. Bankruptcy Code. It’s known as the automatic stay.

It protects a filer against specific creditor actions, which include beginning court proceedings, foreclosure, enforcing a lien on a property, or attempting to repossess the collateral.

This automatic stay begins as soon as you file for either type of bankruptcy.

The automatic stay only applies to the filer and will not apply to any secondary entities such as co-defendants or guarantors.

2. Mandatory credit counseling

You’ll be required to take two mandatory credit counseling courses during the bankruptcy process.

Counseling classes will help you learn budgeting and more so you don’t experience the same cycle of debt in the future.

3. You’ll feel immediate relief

The automatic stay will help ease your financial pressure. It immediately stops debt collection efforts and halts any harassing phone calls from debt collectors while the bankruptcy case is pending. If you’re struggling to have enough money to cover living expenses, you will get some immediate relief.

4. A court-appointed bankruptcy trustee will handle most of the work

It may sound like an intensive process, but once you file a bankruptcy petition, the bankruptcy court will assign a trustee to oversee the case until you get the final discharge.

The court will represent you through the process and manage all contact with creditors. In Chapter 13 bankruptcy cases, trustees receive and process all your monthly debt payments.

5. Bankruptcy prevents more legal action

You can’t be sued for unpaid debts as long as the automatic stay is in place. However, if there’s an active court case pending against you when filing, the automatic stay won’t automatically apply and you may still have to appear in court. Talk to your bankruptcy attorney if you’ve already been sued.

6. You may get to keep some assets

In Chapter 13, you’ll follow a repayment plan to pay off many of your assets, but you can keep them.

Even in Chapter 7, some assets are considered exemptions from liquidation, such as your primary home, vehicles, Social Security, retirement accounts, and any tools or musical instruments required for earning a living.

7. It’s easier to manage back taxes

If you owe the IRS money and you’re experiencing wage garnishment, filing bankruptcy can be an effective way to manage your back taxes.

8. Filing may stop foreclosure or car repossession

The automatic stay will delay or stop a foreclosure or car repossession. It will buy you some time to work out your next steps. A Chapter 13 plan will address these payments. However, these debts will not be discharged by a Chapter 7 filing. You will have to set up a repayment plan.

9. Debts will be settled for less than what you owe

In Chapter 7, creditors will be forced to take whatever payment is determined in your bankruptcy case, which could ultimately mean no payment.

When filing Chapter 13, you’ll be required to pay back some debt depending on what the trustee decides and which creditors are owed funds. The determination is based on your financial situation and ability to repay debts.

10. It removes dischargeable debts

Once bankruptcy is discharged, all unsecured debts that have been written off will be wiped out and you can start anew.

11. Decisions are final

If your creditors approve a deal, they cannot reverse the decision and demand you pay more than the agreed-upon amount.

12. You end up with a clean slate and get a fresh start

Once the process is complete, you can breathe easier. You won’t have any monthly payments and be free to rebuild your life and finances. However, chances are that your credit has been seriously dinged and will need to be rebuilt.

13. You can rebuild your credit score

Many people don’t want to consider bankruptcy because they’re worried about their credit scores. That’s not really the best way to look at the situation. If you’ve defaulted on bills, have accounts that have been charged off or have racked up multiple late payments, your credit score is probably already seriously damaged.

Bankruptcy will likely lower your credit score initially, but you have a clean slate and can pay your bills on time, your score will rebound relatively quickly and you may be able to qualify for new loans or unsecured credit cards in as little as a year.

If you file for Chapter 13, you might see an increase when you start working with creditors. Why? Because it will eliminate debts and lower your debt-to-income ratio, a significant factor in determining a credit score.

Pro tip: Don’t make major financial decisions based on whether you’ll be eligible to borrow more money in a few months. Take this time to focus on your spending habits. Pay cash for everything you buy and assess how you got into debt in the first place.

21 more disadvantages of filing for bankruptcy

Aside from the Chapter 7 means test, there are a few hidden disadvantages, like losing some assets or becoming ineligible to hold specific jobs. Here’s a breakdown of the most significant issues you’ll face:

1. You could lose valuable assets

Depending on the bankruptcy type you qualify for, your income, and the value of your assets, you may lose your home, car, and other secured debts of value, particularly under Chapter 7.

2. The cost

It won’t be free when you finally file for Chapter 7 or Chapter 13 (though there are a few ways to do it cheaply).

The cost to file for Chapter 13 varies from $3,000 to $3,500, depending on the complexity of your case, your attorney’s experience, and where you live.

For example, here’s what it will cost in a few different states:

In California, $3,300 to $5,000
In Texas: $3,000 to $3,825
In Virginia: $4,000 to $5,100

The cost to file Chapter 7 bankruptcy is around $1,500 nationally; however, you might pay more depending on your location and the complexity of your case.

Sometimes, a bankruptcy attorney will offer to take payments, but invoices must be paid in full before the case is filed or the attorney becomes a creditor.

3. Student loans probably won’t be discharged

If you think your student loan debt will be expunged, in almost all cases, it won’t. There are a few exceptions, but it is rare for a student loan to be cleared.

4. Not all financial obligations will vanish

In addition to federal student loans, other liabilities can’t be written off — back taxes, fines, alimony, child support, and/or money owed through other court orders.

5. Co-signers or guarantors must repay the debts

If you’re married or have a co-signer, creditors can demand payment from any non-bankrupt debtor, co-signer, or guarantor on your debt thus making them responsible.

6. You may face potential criminal charges

Failure to repay debt is not a criminal matter and will not land you in jail. However, your trustee and the bankruptcy court will carefully review the information you give during your bankruptcy case.

If you provided false or inconsistent info, this is a criminal offense, and you could face legal action.

7. It can be a lengthy process

A Chapter 7 bankruptcy is a fast process often completed in months. However, Chapter 13 bankruptcy can take years to discharge, and payment plans can range from 36 months to five years.

8. Your business is at risk

If you’re a business owner and your bankruptcy trustee decides your business’ value is high, you might be forced to sell it. Additionally, the trustee may take over your business operations until the sale is complete.

9. You may face eviction after your case is discharged

If you’re a renter and have fallen behind on rent payments, you may face eviction after your bankruptcy case has been discharged. The automatic stay offers protection while your bankruptcy case is pending.

10. You could have trouble renting in the future

Some property owners and management companies automatically dismiss prospective tenants with past bankruptcy on their credit records.

11. It could impact your career

Bankruptcy could disqualify you from holding certain positions at your job, especially in the federal government sector or as a government contractor requiring security clearance.

You’ll also be ineligible to:

Take on certain public office positions
Serve as a charity trustee
Perform any duty as a trustee for a pension fund
Volunteer in any role handling finances
Being employed as a company’s director

12. Your bankruptcy will be a public record

Bankruptcies are publicly reported and discoverable by anyone curious about your finances. Such information cannot be removed from public records unless specific legal circumstances exist.

13. Your trustee may continue to administer your assets

Even after your case is discharged, your trustee can still pursue the sale and distribution of your assets acquired within 180 days of the discharge (for example, an inheritance or a divorce settlement.)

14. Your credit score will fall

Depending on the status of your credit score before filing, you’ll see a major decline and bankruptcy stays on a credit report for seven to 10 years. However, by the time you’re considering bankruptcy, your credit score has probably already taken a pretty severe hit, and you may even have some charge-offs on your credit report. so the impact on your score may not be as damaging as you think it might be.

15. You’ll have trouble getting new loans

Any time you apply for $500 or more in credit, you must report your bankruptcy. The bankruptcy notification will increase the chances of being turned down.

16. You’ll pay high interest rates on new credit

After filing for bankruptcy, you may still qualify for new credit, but it won’t be cheap. For instance, you’ll qualify for “bad credit loans,” which are known to have high interest rates and fees and low borrowing amounts.

17. You’ll have to wait for a mortgage

You won’t be able to qualify for a mortgage for up to four years, depending on the type of loan you want.

18. Your car insurance premiums will increase

Car insurance companies determine their rates based on an industry-specific credit report using information from your credit file. If you need auto insurance after filing bankruptcy, your rates will be higher.

19. It doesn’t address the root of your financial situation

Though you will have to undergo some mandatory credit counseling courses during the bankruptcy process, bankruptcy itself won’t fix your underlying financial issues. If you don’t learn from your errors, you could end up in the same situation again.

20. It’s difficult if you change your mind

Once you’ve filed for bankruptcy, it gets very complicated if you change your mind. You’ll have to seek the court’s permission for dismissal, and you’ll need to provide what the bankruptcy judge considers “sufficient reason.”

21. Bankruptcy is final

This is a long-term decision that will impact your finances, job prospects, housing and future borrowing. That’s why it’s crucial that you consult someone with expertise in your state’s laws to determine your options. Upsolve.org can be a good starting point. Upsolve is a free site that helps filers navigate the bankruptcy process.

22. Some debts may not be dismissed

Bear in mind that some debts may not be covered by either Chapter 7 or Chapter 13 bankruptcy, including:

Mortgages
Tax debts or government fees
Vehicle loans
Child support or alimony
Student loans

Chapter 7 vs. Chapter 13 bankruptcy

There are two types of filings for personal bankruptcy: Chapter 7 or Chapter 13.

Chapter 7

A Chapter 7 bankruptcy, or “liquidation bankruptcy,” can erase many types of consumer debt, the most common are credit card debt and medical bills, including car loans, payday loans, and utility bills. These are known as dischargeable debts. It also will halt wage garnishment if you’re paying the IRS back taxes.

Under Chapter 7, which is designed to offer a filer a fresh start, debts are removed with the court’s approval, but this can take months.

Chapter 7 also has some strict income requirements, which may be challenging.

Chapter 13

A Chapter 13 bankruptcy is known as a wage-earners plan. Chapter 13 is for someone with a steady income who repays all or part of their debt through a repayment or installment plan that’s spread out over three to five years. Chapter 13 is used by individuals, including those self-employed.

There is no income requirement, but the debt must be below a certain amount and stay on your credit report for seven years.

If you decide to file under Chapter 13, you’ll continue to make payments on balances based on the court’s instructed repayment plan, and your trustee will control your finances until your payment plan is complete.

You won’t be in the clear until all unsecured debts are paid back — including credit card debt.

READ MORE: Types of bankruptcy

Should you hire a bankruptcy attorney?

A bankruptcy lawyer can be expensive but don’t worry about that just yet. At the very least, set up a free consultation with a law firm to determine your eligibility and to talk through the filing process. A professional will also know your state’s bankruptcy laws.

After that, some websites will help you file independently if you decide that’s your best option.

Remember, an attorney could charge $1,500 for a Chapter 7 case or upwards of $3,000 for a Chapter 13 case.

NACBA.org provides a database of experienced bankruptcy attorneys.

Bankruptcy alternatives

The bottom line

Sometimes, you need a fresh start, and bankruptcy is the only option.

If that’s the case, it’s essential to be fully aware of the pros and cons before you file.