When To Consider Bankruptcy

Filing for bankruptcy is a major financial move that requires careful thought and consideration. With consumer debt at an all-time high, more Americans are finding themselves overwhelmed. In fact, a total of 370,685 personal bankruptcies have been filed in 2022 alone, and the number continues to rise to this day. But on a positive note, for some individuals, filing for bankruptcy may provide the fresh start they need to move forward. But when is filing for bankruptcy really the right choice? 

This article will guide you in weighing your options, knowing the different bankruptcy types, and considering the key factors before finalizing your decision. 

1. Understand the different types of bankruptcy 

There are several types of bankruptcy filings. The most common options include the following: 

• Chapter 7 bankruptcy: The total debt erase 

If you’re looking for a way to wipe the slate totally clean, Chapter 7 bankruptcy may be the way to go. This ‘liquidation bankruptcy’ erases many (though not all) of your debts completely. The court can erase credit card balances, medical bills, personal loans, and more—giving you a fresh start. 

The tradeoff is that some of your assets could be liquidated or sold off to pay back creditors. However, you do get to keep essentials like clothing, basic household items, and any property that’s exempt in your state. One big plus of Chapter 7 bankruptcy is that it only stays on your credit report for 10 years. So, while credit scores take an initial hit after filing, you can rebuild your credit over time. 

Chapter 7 makes the most sense for those lacking enough income to keep up with payments or those with few assets they need to protect. Preferably, talk to a bankruptcy attorney to get specifics on whether it fits your financial situation. 

• Chapter 13 bankruptcy: The debt repayment plan 

If wiping all your debt away with Chapter 7 sounds too drastic, Chapter 13 bankruptcy may be a better fit, especially if you have a regular income. With Chapter 13, you get to keep your property like your home or car—in exchange for repaying some of what you owe over time. This ‘reorganization bankruptcy’ involves committing to a 3–5-year repayment plan approved by the court. How much you repay depends on your income level and debts. 

A major benefit is catching up on mortgage or car loan payments and avoiding foreclosure or repossession. Another perk is that Chapter 13 bankruptcy only stays on your credit report for seven years. So once your repayment plan is complete, your credit score starts recovering. 

If you have regular income to support consistent payments, Chapter 13 could be a good compromise to pay back debt while protecting assets. 

• Chapter 11 bankruptcy: The business restructure 

If your business struggles with serious debt, Chapter 11 bankruptcy may be your lifeline to restructure and move forward. Just recently, in 2022, about 13,125 businesses in the US filed for Chapter 11.

The primary benefit is that businesses can continue operating while working out a new repayment plan for creditors. So, unlike Chapter 7, where assets get liquidated, Chapter 11 allows you to reorganize debts and cut expenses while still running your company. 

Throughout the process, you, as the business owner, maintain control over operations. So Chapter 11 bankruptcy essentially presses ‘pause’ financially so your business can recover. 

2. When is the right time to consider filing for bankruptcy? 

With how much bankruptcy affects your finances, timing is important. No one wants to file too late when damage is already done or too early before considering all options. 

Filing may make the most sense when: 

• You've fallen several months behind on debt payments 

• Creditor harassment is nonstop 

• Wage garnishment or lawsuits have started 

• Your debt-to-income ratio is unfavorable 

• Foreclosure or repossession is imminent 

• You’ve tapped alternatives like debt management without success 

Being proactive can allow you to file under your preferred chapter. Waiting until debt compounds even further may limit options. 

Consult your specific situation with a bankruptcy attorney. If the benefits seem to outweigh the tradeoffs in your circumstances, that may signal it's time to pursue filing. The sooner you can restore financial stability, the faster you can start rebuilding for the future. 

3. Know the qualifying criteria and steps to file 

Before getting bankruptcy relief, you’ll need to prove you meet certain criteria set by the court. Qualifications are based on your income, assets, debts, and finances. 

For Chapter 7 bankruptcy, you can’t have too much disposable income left over each month after living expenses. The courtroom test is whether it would be an ‘undue hardship’ for you to repay debts. 

To file Chapter 13, you’ll need to show regular income that can support making repayment plan payments consistently. The average Chapter 13 payment plan is around USD$400 per month nationwide. 

Steps to file generally involve extensive paperwork like tax returns, income documentation, budget analysis, and more. You must also complete mandatory credit counseling and financial management courses. Court filing fees apply as well. 

4. Weigh bankruptcy’s pros and cons 

Like any major financial move, filing for bankruptcy comes with both potential drawbacks and benefits to weigh carefully. 

On the pro side, bankruptcy immediately halts collections calls, lawsuits, foreclosures, and garnished wages, giving you breathing room from debt. Another perk is eliminating some debt completely while restructuring and repaying the rest over time. 

However, bankruptcy also comes with significant cons. For starters, it devastates your credit score—the average drop is 130 to 150 points after filing. That makes getting approved for loans and credit very difficult down the road. For businesses, Chapter 11 stops creditor harassment while reorganizing—but the legal fees average over USD$100,000. And any debts not discharged must still be repaid. 

Overall, weighing these key tradeoffs will help determine if bankruptcy is your most strategic choice. 

The Takeaway 

Declaring bankruptcy isn't an easy choice or one to take lightly. It can really do a number on your credit and finances for years. But sometimes, it may feel like the only way to come up for air. If you weigh the pros and cons and determine if the debt relief is worth the credit damage and legal complexities, bankruptcy might just give you the fresh start you desperately need. While it'll take time to rebuild your credit, bankruptcy can be an empowering reset button financially, as long as you go in with your eyes wide open about what it involves.