8 Things to Consider Before Filing Bankruptcy

1. Have You Exhausted Your Other Options?

The serious ramifications of bankruptcy mean it should usually be considered only as a last resort. Before pursuing it, it's good to explore bankruptcy alternatives, including the following, which are listed in decreasing order of how much harm they'll likely do to your credit standing:

• Credit counseling: A certified nonprofit credit counselor can help you sort out your finances, look for ways to get debt under control and offer guidance even if bankruptcy turns out to be your best option. Credit counselors typically charge modest fees, and some offer sliding-scale fees based on your ability to afford them.
• Debt consolidation: If your credit is still sound, consolidating high-interest credit card debt by paying it off via a relatively low-interest personal loan or a balance transfer card with a low introductory annual percentage rate (APR) can be a sound strategy.
• Debt management plan (DMP): A credit counselor will try to help you adopt smart budgets and other economizing measures, but if that's not enough to get your debts under control, they may be able to intervene with creditors on your behalf to set up and manage a debt management plan. A DMP allows you to make full or partial repayment to creditors in smaller amounts than your regular payments would require. This typically leads to cancellation of credit accounts and damage to your credit scores, but it can be less severe than bankruptcy.
• Debt settlement: Expensive and potentially devastating to your credit, for-profit debt settlement companies typically have you withhold payments to your creditors and instead funnel cash into a dedicated bank account (often with monthly fees) that they use to offer your creditors partial repayment of what you owe. Debt settlement often increases customers' debt levels and, because creditors may not accept their terms, could still lead to bankruptcy.

2. Which Type of Bankruptcy Should You Pursue?

Two types of bankruptcy protection are available to individuals in the U.S.:

• Chapter 7: Also known as liquidation bankruptcy, Chapter 7 requires you to forfeit property and other assets valued beyond a limit that varies by state. Forfeited assets are sold under the supervision of a bankruptcy trustee and proceeds are distributed among your creditors.
• Chapter 13: Sometimes called the wage-earner's plan, Chapter 13 bankruptcy establishes a repayment plan lasting three to five years, during which time you make regular monthly payments to a bankruptcy trustee, who then distributes the funds to your creditors.

Eligibility criteria, including a means test, may determine that you only qualify to file for one type of bankruptcy or the other, but in cases where either path is possible, the answers to the questions that follow may help guide your choice of which to pursue.

3. Does Your Debt Qualify for Bankruptcy?

Bankruptcy can cancel (or discharge) many types of consumer debt, including credit card balances, personal loans and unpaid rent and medical bills. But there are a number of types of debt bankruptcy cannot erase, including:

• Unpaid alimony and child support
• Certain unpaid criminal fines
• Certain student loans
• Unpaid taxes

If all or most of your debt falls into these categories, a Chapter 13 repayment plan may help you get caught up on delinquent payments, but it cannot eliminate the obligations altogether.

4. Do You Have Assets You Want to Protect?

Both Chapter 7 and Chapter 13 make allowances for retaining a portion of what you own, but only Chapter 13 can prevent lenders from seizing the collateral on unpaid secured loans such as mortgages or auto loans. If you are behind on car or house payments, a Chapter 13 repayment can halt the foreclosure or repossession process, enabling you to get caught up on payments and letting you keep the asset, provided you make future payments on time.

5. Should You Hire an Attorney?

It's possible to represent yourself in a bankruptcy case, but hiring a bankruptcy attorney is highly recommended. A lawyer familiar with bankruptcy procedures can help you avoid missing filing deadlines and prevent other missteps that could impede your case.

In a Chapter 7 case, you must pay your legal fees up front and in full before the case is finalized. In a Chapter 13 case, your legal fees can be incorporated into your payment plan.

6. What Are the Consequences of Bankruptcy?

Bankruptcy can have negative repercussions that last for years, including loss of assets and deep, long-lasting damage to your credit scores.

Chapter 13 bankruptcy appears on your credit reports for seven years from the month you filed for protection. Chapter 7 bankruptcy appears on your credit reports for 10 years from the month you file.

Bankruptcy hurts your credit scores as long as it remains on your credit reports, but the extent of its impact lessens over time—especially if you practice good credit habits after your bankruptcy. And while some lenders consider a bankruptcy on your credit report grounds for denying any credit application, others may begin offering you loans (typically with steep interest rates and fees) within a few years of your filing date.

7. What Should I Do Immediately After Bankruptcy?

You can take steps to begin rebuilding your credit as soon as your bankruptcy is finalized. Some options include:

• Get a secured credit card. Getting a secured credit card by placing a cash deposit that serves as some or all of your borrowing limit and then using the card prudently can help you reestablish a pattern of on-time debt payments. A pattern of timely payments can benefit your credit scores.
• Become an authorized user. Becoming an authorized user on a credit card held by a friend or family member with good credit can help your credit scores by letting you share in that card's positive payment history.
• Take out a credit-builder loan. A credit-builder loan can benefit your credit scores and help you save a little money. You borrow a small sum, often $1,000 or less—but sometimes as much as $3,000—which is placed in a special off-limits interest-bearing savings account. You repay the loan in installments over a span of up to 24 months, generating positive payment activity on your credit reports, which can improve your credit scores. If you don't keep up with payments, the lender keeps the money in your account. But if you repay the loan in full, the account and its contents are yours to use as you please.
• Sign up for Experian Boost^®ø. Bankruptcy often leaves you with fewer credit accounts, which can mean fewer on-time payments on your credit reports to promote credit score improvement. Experian Boost can help offset this by adding your history of paying utility bills, streaming subscriptions, rent and other recurring expenses to your Experian credit report. Many users see instant increases in FICO^® Scores^☉ calculated using Experian data.

8. Should You Change Your Habits to Prevent Future Missteps?

Bankruptcy can be rooted in unavoidable misfortune (medical crises, natural disasters and the like), but it also can stem from mismanagement of personal credit accounts. If your consideration of bankruptcy arose from excessive credit card purchases, loan installments that proved unaffordable or other errors in judgment, you'll do well to reflect on your choices and vow not to repeat your mistakes. Credit counseling can be a big help with this.

The Bottom Line

Bankruptcy is not a step to be taken lightly. If, after considering the preceding questions and consulting trusted advisors, you decide to move ahead with Chapter 7 or Chapter 13, you and your credit can recover. Time will lessen the negative consequences for your credit scores, and within just a few years, some lenders may even extend you offers for loans or credit cards. To track your credit recovery and to understand how lenders will likely view your credit applications, check your credit score from Experian for free.