When Should I File for Bankruptcy?

Despite what many think, filing for bankruptcy is not the end of the world. It can actually be the fresh start you have been looking for. The laws of bankruptcy were drafted with the purpose of giving people a second chance, and not to punish them.

But that doesn't mean you should file for bankruptcy at the first sign of financial distress. Declaring bankruptcy will have short- and long-term consequences and should only be done as a last resort. So, when should you file for bankruptcy?

Before You File, Evaluate Your Situation

When should I file for bankruptcy? This is a question most people under financial distress ask. You should probably consider other options before going this route. These options include:

• Getting credit counseling
• Trying to negotiate your debt or make a payment plan with your creditor
• Sticking to a budget

If, however, other options don't seem feasible, filing for bankruptcy may give you the ability to get a fresh start.

What Is Bankruptcy?

Bankruptcy is a process by which you can discharge some of your debt because you are unable to repay those debts. There are usually two ways bankruptcy is declared:

• You file for bankruptcy
• Your creditors ask the court to declare you bankrupt

Bankruptcy usually takes two forms: Chapter 7 and Chapter 13.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy, otherwise known as “straight bankruptcy" or “liquidation," allows the debtor to sell their non-exempt assets to pay off their debts; after that, the debtor will be free from all dischargeable debts.

There are specific eligibility requirements that you must meet to qualify for Chapter 7 bankruptcy. Some of the scenarios where you wouldn't be eligible for Chapter 7 include:

• Your income is too high (this is determined using the “means test"): In such cases, your case may be filed under chapter 13 bankruptcy
• You have the ability to repay your debt
• You dismissed a bankruptcy case within the past 180 days
• You previously filed for bankruptcy and the time frame to file another bankruptcy case has not passed
• You attempted to defraud creditors

If you would like more details on Chapter 7 bankruptcy and how the process works, Findlaw.com's Chapter 7 bankruptcy section has plenty of resources.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy requires you to make a repayment plan to pay creditors over a period of three to five years. This method is usually used if your income exceeds the limits set for Chapter 7 bankruptcy.

You also need to show you comply with the eligibility requirements before you can file Chapter 13. These include:

• You are not a business organization
• You took credit counseling
• You have not dismissed a Chapter 13 case within the past 180 days
• You have not filed for a Chapter 13 within the past two years

Findlaw's Chapter 13 bankruptcy section has specifics on whether you can qualify for a Chapter 13 bankruptcy.

Things You Should Know Before You File for Bankruptcy

Before you decide to declare bankruptcy, there are a few things you should consider. These include:

Not All Debts Will Be Discharged

You should know that bankruptcy does not wipe out all your debts. Some debts that will not be discharged include:

• Student loans
• Child support
• Alimony
• Court fines or penalties

Debts such as credit card debts, loans, lease and contract obligations, and medical bills can be discharged.

Declaring Bankruptcy Will Affect Your Credit Score

In exchange for discharging your debt, filing bankruptcy shows everyone that you may be a credit risk, which will be reflected in your credit score. Thus, getting a loan, a mortgage, or a credit card may be very difficult after declaring bankruptcy.

You should note bankruptcy filed under Chapter 7 will remain on your record for 10 years. If you filed under Chapter 13, it would stay on your credit report for 7 years. After that, it is erased.

Your Co-Signers May Be Required to Pay Your Debts

Co-signers are people who agree to pay your debt if you are somehow unable/unwilling to pay the debt. If you file a Chapter 7 bankruptcy, your creditors are allowed to go after the co-signer even if your bankruptcy case is successful.

Under Chapter 13, your creditors can't go after your co-signer as long as you make your regular payments per your agreement.

Filing for Bankruptcy During a Pandemic 

Filing for bankruptcy during a pandemic or other national emergency may be challenging, as operational hours for courts may change. So, first, make sure your local bankruptcy court is open and taking cases before you file. You should also expect a delay in the processing of your case.

The Federal Government May Intervene

Under rare situations, the federal government may pass laws that could affect your bankruptcy case during a pandemic. For instance, the federal government passed a stimulus bill in response to the COVID-19 pandemic. 

Under this stimulus bill, several temporary changes were made to the bankruptcy code. Some of these changes include:

• Previously, the debt limit to be eligible to file for bankruptcy under the Small Business Reorganization Act (SBRA) was $2,725,625. Under this stimulus bill, the debt limit was increased to $7.5 million for a period of one year.
• The bill also changed the definition of "income" for Chapter 7 and 13 bankruptcy filers. Accordingly, payments received from the federal government that are related to COVID-19 are not considered income for purposes of bankruptcy.
• People with federal student loans can, without penalty, defer their payments for six months through September 30, 2020.
• People who already filed a Chapter 13 and are under a repayment plan can make modifications if they can show "material financial hardship" because of the pandemic. The modifications include an extension of payments for seven years.

Related Resources

• Bankruptcy: Frequently Asked Questions
• Bankruptcy: Advantages and Disadvantages
• Protecting My Small Business During a Pandemic

Speak to an Attorney Before You File for Bankruptcy

If you are considering filing for bankruptcy, it is very important you have all the information you need, especially since bankruptcy laws tend to be detailed and complicated. Speaking to a bankruptcy attorney near you may be the best way to ensure your rights are protected.