If you’ve found yourself unable to pay your bills because of the coronavirus pandemic, you might be wondering whether the solution to your financial woes is to file for bankruptcy.
Money expert Clark Howard has been helping people in difficult financial situations find solutions for more than 30 years.
In this article, we’ll talk about who should — and shouldn’t — consider filing for bankruptcy, the impact filing could have on your life and some alternatives you should consider before you file.
How Do You Know When To Declare Bankruptcy?
If you’re deep in debt, the idea of making those financial obligations seem to vanish might be tempting. You might have even seen television commercials urging you to call a 1-800 number to get the process started.
Clark takes a strong position on bankruptcy as an option for individuals.
“Bankruptcy is a late-in-the-game resort,” he says. “I find a lot of people see those ads on TV. They’re getting calls from a collector. They just want those collection calls to stop, so they file for bankruptcy. But that’s not a reason to file. You’ve got to have things like judgments against you before filing for bankruptcy starts to make a lot of sense.”
Clark says there is only one good reason to file for bankruptcy.
“The reason you file bankruptcy is because you’re at a point where you’re never going to be able to work your way out of the debts you have,” he says. “And that’ll happen sometimes. But most of the time, you’ll be in a position where you’ll be able to handle the debt as long as you come up with a plan.”
Alternatives to Filing for Bankruptcy
Because bankruptcy can be so devastating to your long-term financial health, Clark has devised a three-step plan to follow before you consider the B-word:
- See a certified credit counselor who is an affiliate with the National Foundation for Credit Counseling. You can find someone with an office near you by searching NFCC.org.
- With the counselor, go over all your outstanding debts and income and see if you can come up with a budget that works for you. If nothing can be done in that regard, there’s still another option.
- See if your credit counselor can contact your creditors and negotiate payment plans. You’d be surprised how many companies will settle for pennies on the dollar just to get something for their troubles. If you’re able to work out an overall payment plan, you can expect it to take about three or four years to get out of debt — but your credit and buying power will be intact.
If you follow these steps and you find you still can’t pay your creditors, Clark has one more suggestion.
“Just stop paying,” he says. “If you’re overwhelmed, you’re allowed to tell collectors they can’t call you anymore. Do that before you file for bankruptcy. Bankruptcy hangs over you for so long after you file.”
The Differences Between Chapter 7 and Chapter 13 Bankruptcy
If you find yourself in a position where bankruptcy is the only viable option, it’s important to understand the most common types of bankruptcy available to individuals: Chapter 7 and Chapter 13.
You’ve probably heard about Chapter 11 bankruptcy most often — maybe in news stories — but it’s primarily for businesses or people who have a lot of assets and debts.
Bankruptcy has some advantages. Namely, it stops creditors from nagging you constantly about what you owe them. But there are some real disadvantages as well. In many cases, you may be forced to sell some assets, like your home. And bankruptcy can devastate your credit score for up to 10 years.
“Each Chapter has its advantages and disadvantages,” according to longtime bankruptcy attorney Bernd Stittleburg of Duluth, Georgia. “The main difference between Chapter 7 and Chapter 13 is that Chapter 7 will allow the debtor to eliminate all dischargeable unsecured debt, whereas Chapter 13 would allow for payments to be made on those debts.”
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is typically for people who are completely destitute, while Chapter 13 bankruptcy is more of a repayment assistance plan scenario.
In typical Chapter 7 bankruptcies, a trustee is appointed to your case and is given the authority to sell your non-exempt assets to pay your creditors.
“A lot of people will fail the means test for a Chapter 7 bankruptcy, and they have to do a Chapter 13 first,” Clark says. “Only if that fails can they do a Chapter 7. And Chapter 13 is no picnic. You’ll be put into a plan where a trustee controls your checks and they can come up with a payment plan that takes as long as five years.”
“Chapter 7 is where the debtor does not have the discretionary income needed for a Chapter 13 and usually has no assets that are worth very much — or even if they have assets such as a home or car, neither has equity,” Stittleburg says.
“This then allows that debtor to eliminate all unsecured debt and keep secured debt and the assets associated, assuming he or she can continue making the payments,” he says.
Chapter 13 Bankruptcy
When someone files for Chapter 13 bankruptcy, it may not mean they don’t have any funds but that they just can’t make immediate payments, as might happen with a job loss. That’s why, in many ways, Chapter 13 is more of a debt reorganization plan.
“Of course, there has to be some money left in your budget of future projected income and expenses to fund your plan,” Detroit, Michigan-based bankruptcy lawyer Kurt O’Keefe tells Team Clark.
“Your plan payment is the difference between your projected income and expenses. That also must be enough to pay your creditors at least what they would get in Chapter 7,” he says.
Bankruptcy is not something to be taken lightly.
“My experience is that, when it really makes sense to file for bankruptcy, is when you have debts that you’re never, ever going to be able to pay — or you have judgments against you that you have no way of ever satisfying,” Clark says. “It’s a last resort. You’re just out of cards to play.”
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