There are around 1,000,000 bankruptcies every year in the US.

Obviously, it’s a problem. A problem that can be avoided, but if you’re past the avoiding stage, it may be your best option.

Let’s dive in and discuss the different types of bankruptcy, when to file, when not to file, and the effects of filing.

What is Bankruptcy?

The actual definition is “the state of being bankrupt.”  Well that explains everything.

Bankruptcy is when you can’t pay your debt (personal or business) and you have to find a way to get rid of it.  It’s a fresh start, kind of.  But as you know, there are negative effects and consequences.

Generally the process involves paying your outstanding debt with your assets, but not always.  It depends on the type.

Here are the primary forms of bankruptcy you may need to know about:

• Chapter 7 – Assets are liquidated, if you have them.  This includes all property, vehicles and even furniture; however, your state will work with you to help you keep the things you need, like your homestead, clothing, furniture, and in some cases, vehicles.  Once your debt is wiped out with a Chapter 7, you will not make payments on it.  It’s simply gone.  But a Chapter 7 won’t wipe out everything.  Things like school loans, child support and taxes will stick around, and you’ll still have to pay them.  There are also income restrictions to file for Chapter 7.
• Chapter 11 – This is available to businesses or individuals, but you will rarely, if ever, hear of an individual filing Chapter 11.  Chapter 11 is a way for a company to reorganize their debt, but it is very expensive.  Generally small businesses stay away from this type of bankruptcy, because it’s difficult for them to continue operations after paying for it.  You will most often hear about Chapter 11 from major corporations.
• Chapter 12 – You haven’t heard about this one much, because it is only available to farm owners and commercial fishermen.  Chapter 12 is setup in a way to help them specifically.  The debt limits are much higher than other options, which is necessary for people who own a few thousand acres.  Ideally, this option would allow farmers and fishermen to keep their land and occupation.  There is a five year limitation on the restructuring plan, which means the debt must be paid within five years.
• Chapter 13 – If you have disposable income left over at the end of the month, after all bills are paid, you can’t file Chapter 7, so Chapter 13 is generally your best option.  Or if you make more money than Chapter 7 allows, Chapter 13 is your best bet.  Chapter 13 requires a 3-5 year payment plan for all of your debt.  After your payment plan concludes, all of the debt included in the bankruptcy is wiped out.  Basically, if you can afford to pay something, you will be directed to file Chapter 13, if you can’t and your income is low, Chapter 7 may be better.

There are a couple other types of bankruptcy.  They include Chapter 9, which is for cities and towns to reorganize their debt, and Chapter 15, which is applies to people who have debt within the US and outside the borders.  I’m not going to go into detail about these, because you most likely don’t need them!  Unless you own a city or something.  Do you own a city?

When to File Bankruptcy (And When Not To)

Bankruptcy can be devastating to your financial situation on paper, but it can also provide relief.  Sure, it can hurt your chances of getting another loan in the future, but if you’re facing bankruptcy, the last thing you should be worried about is another loan.

Simply put, bankruptcy is for people who owe more than they can afford.

If your bills are behind, creditors are calling, you’re barely making minimum payments and you don’t see another way out, bankruptcy could be an option for you.  It is a solution to a completely overwhelming financial situation.  It would be better to file for bankruptcy than to sacrifice your health over the stress of a financial meltdown.

There is a really popular bad reason to file for bankruptcy.  It’s becoming more and more popular to get into a poor financial situation by being completely financially irresponsible.  Then file for bankruptcy and hopefully keep all of your stuff.  Some people do this on purpose, knowing that they can just file for bankruptcy once they buy too much stuff.  This is basically a form of strategic default.  And it’s really popular with mortgages.

Especially after the housing bubble popped, people have been walking away from homes that they could afford, because they owned way more than the home was worth.  If you can afford to make the payment, and you purposely don’t, that’s strategic default.  There’s nothing responsible or commendable about strategic default.  Any self-respecting adult should see that.  So don’t do that.

File for bankruptcy when you see no other way out of the situation.  If you’re just in a lot of debt, but you’re able to pay it, read our Get Out of Debt Guide or go talk to a professional.  Consolidate your debt if you have to.  But bankruptcy is only for an otherwise unsolvable situation.  You don’t want to file for bankruptcy on a whim, and I’ll explain why below.

What to Do Before Filing for Bankruptcy

So you’ve decided that bankruptcy may be for you.  You don’t see another way out.

The process for filing isn’t always fast, but it is relatively easy.  However, before you file for bankruptcy, you should do a few things:

• Get your finances in order.  Make sure you need to file for bankruptcy.  After you get all of your finances in front of you, you may see that you don’t need to file for bankruptcy, you just need a plan.  You may be able to make it work.  It almost always seems worse than it is, until we actually look at it on paper.
• Figure out which debts won’t be forgiven.  As mentioned earlier, things like student loans and taxes are not forgiven with bankruptcy.  You may find that most of your debt comes from debt that isn’t going to be wiped out with bankruptcy.  In that case, you don’t need bankruptcy, you need to call the lenders (schools, student loan companies, the government, etc.) and tell them you’re unable to pay.  They will usually set up a payment plan.
• Think about your co-signers.  Co-signing is almost never a good idea, but you may have talked some people into co-signing for you in the past.  If so, you should make sure they aren’t stuck with you debt when you file.  It depends on the company you took the loan out with, but it’s not uncommon for a co-signer to be stuck with the full balance once you file for bankruptcy.
• Assess what will be affected. Do you have a home?  Other property?  Vehicles?  Furniture?  Retirement plans? These are all things that could potentially be affected and taken from you when you file, though some of these things are usually protected, such as retirement plans.

You have to be prepared when you file for bankruptcy.  The last thing you want is to file without realizing your home is going to be taken away.  Then you’re bankrupt and practically left on the street.  I’ve personally known people who lost everything and were literally living on the street with their family.  Full disclosure: this happened before I met them; otherwise, they would have been welcomed at my house.

The Negative Effects of Bankruptcy

Bankruptcy stays on your credit report for seven to ten years.  So what does that mean?  It means that you will have a hard time doing anything that involves your credit report for several years.  This includes getting a loan, but it also includes things like getting hired.

In the scope of life, a decade isn’t as long as it sounds, but you will have to expect your life to be different until you’ve fully recovered from the bankruptcy.  It’s good that you can’t file for bankruptcy and then immediately go out and get back into the same amount of debt, and that’s why it has that effect on your credit report.

That being said, when you file for bankruptcy, it’s likely that you will start seeing credit card offers immediately.  Why? Because they know you filed for bankruptcy and they know you can’t file again for a long time; therefore, they send the offers.  Obviously this is a trap.  Your interest rates are going to be astronomical, and they will promote the credit offers as a way to bring your credit score back up.  Don’t fall for it.

Once you file, you should wait a long time before even considering more credit cards.  Credit cards are great if you use them responsibly, but there’s a good chance that using them irresponsibility is what got you into bankruptcy in the first place.  In that case, I highly suggest using cash for at least the seven to ten years your credit is hurting.  Then, and only then, can you possibly make the decision to start using credit cards again, but you have to be honest with yourself about your level of responsibility.  You don’t want to file for bankruptcy twice, do you?

There are some other areas that are affected by bankruptcy, but they aren’t often talked about.  For example, if you want to join the military, a bankruptcy could hold you back.  It’s not impossible, but it will require a waiver, and waivers don’t always get approved.

Your best bet is to avoid bankruptcy unless the benefits outweigh the consequences.