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.

Table of Contents

What is the difference between Chapter 7 and Chapter 13 bankruptcy?

In general, there are two types of filings for personal bankruptcy; Chapter 7 or Chapter 13.

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 difficult to meet.

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.

Whichever works best for you can expect some exemptions to protect your personal property such as primary residence, vehicles, retirement accounts, and Social Security benefits.

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

What are the pros and cons of filing for bankruptcy

Before you make your decision, know that there are various pros and cons to filing bankruptcy. They’re generally about the same whether you file for Chapter 7 or Chapter 13.

Here are 13 pros 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.

This is an automatic stay that begins as soon as you file for bankruptcy and applies to individuals and businesses under Chapter 7 and Chapter 13. 

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

What are automatic-stay provisions exactly?

These provisions protect a filer against certain creditor actions, which include beginning court proceedings, foreclosure, enforcing a lien on a property, or attempting to repossess the collateral. 

The automatic stay applies to debt collection and will also halt any harassing phone calls from debt collectors while the bankruptcy case is pending.

2. Mandatory credit counseling may help you learn from past mistakes

More than just the court saying, ‘you’re free,’ 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 financial woes in the future.

3. You’ll feel immediate relief if you’re dealing with multiple creditors

While filing for Chapter 7 or Chapter 13 will alleviate stress, you’ll need to follow the rules to the letter, and depending on the type of bankruptcy you file this will determine how the process unfolds.

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

Also, the automatic stay protects the filer from most collections efforts but if there’s a court case pending against you when filing, bankruptcy may not always put you in the clear. 

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 will be able to keep them. 

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

7. It’s easier to manage with 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. The IRS has options for dealing with unpaid tax bills and can help you qualify for bankruptcy via Chapter 7 or Chapter 13.

8. Filing may temporarily stop foreclosure or car repossession

Chapter 13 bankruptcy may delay or stop a foreclosure or car repossession, whereas with Chapter 7, the automatic stay will buy you some time before the tow truck pulls up. 

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 at all. 

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 current 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

Luckily, if your creditors approve a deal, they cannot reverse the decision and demand you pay more than the amount agreed on.

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

After all, is said and done, and you’ve been granted Chapter 7 or Chapter 13, you can breathe easier. You won’t have any monthly payments and you’ll 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. Potential to boost credit score (down the road)

Speaking of credit scores, yours was probably bad before you filed, and Chapter 7 will make it worse. If you choose Chapter 13, you might see an increase if you’re working with creditors. Why? because it will eliminate debts, lowering the debt-to-income ratio, a major factor in determining a credit score. 

The main con of Chapter 7: The Means Test

To be eligible to file for Chapter 7, a filer must pass a Means Test, which is a method for determining if the filer qualifies for financial assistance to obtain a service or goods such as welfare payments.

​Here are 21 other cons of filing for bankruptcy

The biggest con is going to be the impact on future borrowing, but there also are some other hidden disadvantages, like you could be ineligible to hold certain jobs. Here’s a breakdown of the biggest 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

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

The amount to file for Chapter 13 ranges from $3,000 to $3,500, depending on the complexity of your case, attorney 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 runs around $1,500 nationally; however, you might pay more depending on your location and the intricacy 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 like a creditor.

3. You probably won’t get rid of your federal student loans

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 your 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. If you have joint accounts, the other party is still responsible

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

Can you land in jail if you fail to pay back funds? Debt is typically a civil matter, so no, you won’t face criminal charges for not repaying creditors. 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 face eviction, but only after bankruptcy has been discharged. The automatic stay offers protection while your bankruptcy case is pending.

10. You could have trouble renting in the future

For future reference and if renting, some property owners, and management companies automatically dismiss prospective tenants with a past bankruptcy on their credit record.

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 who may be curious about your finances. Such information cannot be removed from public records unless there are specific legal circumstances.

13. Your trustee may continue to administer your assets after discharge

Even after your case is discharged your trustee can still pursue the sale and distribution of your assets that have been acquired within 180 days of the discharge (i.e.. an inheritance or a divorce settlement.)

14. Your credit score will drop in the short term

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 credit of $500 or more, you must report your bankruptcy. The bankruptcy notification will increase the chances of being turned down, or at the very least will significantly increase the interest rate you’ll pay.

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

You may still qualify for new credit after filing bankruptcy, 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 limits.

17. Any home purchase plans will be set back

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, and 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 have a lasting impact on 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.

What actually happens once you’ve filed? Check out this video to learn more:

Should you hire a bankruptcy attorney?

There are many pros to hiring a bankruptcy lawyer including advice on whether Chapter 7 or Chapter 13 is the best option. A professional will know your state’s bankruptcy laws and could offer you a free consultation.

Again, this type of attorney isn’t cheap and could cost $1,500 for a Chapter 7 case, or upwards of $3,000 for a Chapter 13 case. 

The bottom line

If you feel you’ve exhausted all possibilities and can’t repay your debts filing for Chapter 7 or Chapter 13 bankruptcy might be an option. Seek legal counsel to help you with your case to guide you through what could be a long process. 

In the end, once the case has been completed and all debts erased, you will surely feel relief. 

Be sure not to fall into the same trap of overspending, do learn how to budget to avoid future financial woes.

FAQs

What are my other options for debt relief? Debt management plan, debt settlement, debt consolidation?

You have a few options:
A Debt Management Plan (DMP): These are set up by a credit counseling agency. They will work out a payment plan on your behalf. There will be a small monthly fee.
Debt settlement: This involves negotiating with lenders and creditors, and you’ll pay less than what you owe. You can do it yourself, or pay a debt settlement company to handle it for you.
Debt consolidation: This involves taking out one larger loan, ideally with a lower interest rate, and using it to pay off your other debts. With only one monthly payment to worry about, it can ease your financial crunch and save you money in late fees.

Where can I find a bankruptcy attorney?

Check a free legal clinic or try the Legal Aid Society for help. If your income is currently below the national average for the number of people in your household, you could qualify for free legal help. Or: American Bar Association (findlegalhelp.org), Legal Services Corporation (LSC.gov), and the federal court system (uscourts.gov). Avvo (avvo.com) and Martindale-Hubbell (martindale.com) are often used for finding affordable bankruptcy attorneys.

Will I go to jail for not repaying my debts?

No, defaulting on loans is a civil matter, not a criminal one, so you will not go to jail for that.. However, you could be sent to jail for the debt if you violate a court order. 

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