Filing bankruptcy isn't the last resort you might think
Filing bankruptcy is supposed to be your last resort option, the very last financial tool you want to use. But is there a situation where filing chapter 7 bankruptcy is your best choice?
In this video, we’ll look at what happens when you file bankruptcy and how to know when it’s time!
2020 Bankruptcy Filings Jump
Hey Bow-Tie Nation, Joseph Hogue here and wanted to do this video today because we could be about to see a surge of bankruptcies across the United States.
More than 30 million people are unemployed, one-in-ten Americans, more than the entire population of Texas. and that extra $600 in weekly unemployment benefits runs out on July 31st, leaving a lot of people with no other option.
I want to make this video a complete guide to filing bankruptcy from pros and cons to other options because with that depression we could be in for, you can bet the fraudsters and scammers will be out trying to take advantage of anyone down and out.
That’s why I contacted Upsolve to partner for this series of videos. Upsolve is America’s largest bankruptcy non-profit. The app helps you file bankruptcy without a lawyer and has helped users clear over $206 million since 2016.
Now we’ll look at other options like debt settlement and consolidation but a lot of these companies are anything but non-profit. Upsolve receives 80% of its funding from federal grants and philanthropic charities and I’ll show you later how it can save you thousands on bankruptcy costs.
So I first want to cover the basics, a quick definition of chapter 7 and 13 bankruptcy and then some other options you might try before. We’ll look at the pros and cons and then three scenarios to give you an idea of when filing bankruptcy is your best option.
What Happens when You File Bankruptcy?
Now at its most basic, bankruptcy is a legal process to relieve overwhelming debt on a person or company. You file with the court and someone is assigned to look over your finances to determine how much of your debt is wiped clean.
It’s a chance to start over when there’s no other way out and the reasoning comes from the old days where if you couldn’t pay your debts you went to debtor’s prison. Families were split up and you were basically made a slave…we’re talking real life Oliver Twist stuff!
So to give people a way out, bankruptcy was created as a solution when there was no other option.
And there’s actually two types of bankruptcy for individuals, chapter 7 and chapter 13.
What is Chapter 7 Bankruptcy?
Chapter 7 bankruptcy is the one most people think about, when you file to have your debts wiped clean. This is when you don’t make enough money to reasonably keep up and you don’t have a lot of property you can sell.
Understand that not all debt can be relieved in a bankruptcy. Child support and alimony, and any debt on your home or car won’t be forgiven if you keep the property. Student loans can be discharged but it’s very rare.
What is Chapter 13 Bankruptcy?
Chapter 13 bankruptcy, also called a wage earner’s plan, is for people that make too much money to file chapter 7, usually around the median household income in your area, or that have a lot of assets they don’t want to lose.
In Chapter 13 bankruptcy, the court makes a plan for you to pay off the debt over three- to five-years. You might be able to get some of the debt forgiven to a level you can repay and you get to keep all your property.
Pros and Cons of Filing Bankruptcy
Pros of filing bankruptcy are that immediate relief from the debt, from those constant collection agency calls and you get to start over. When you file bankruptcy, even before it’s finished, all creditors have to stop harassing you immediately in what’s called an automatic stay.
During the bankruptcy, you can’t be evicted and your home can’t be foreclosed. Your utilities can’t be turned off for non-payment and some people with really bad credit even see their credit score start increasing soon after bankruptcy.
As we say here on Let’s Talk Money though, it’s not all rainbows and unicorns. That bankruptcy will stay on your credit report for up to 10 years, making it difficult to get a mortgage or big loans for three- to five-years. You won’t be able to file bankruptcy again for eight years and you could lose some of your assets like a second home or cars in that Chapter 7.
Anyone that co-signed for a loan that you discharge in bankruptcy, they’re on the hook now for that money. Then there’s the cost…the average cost to file bankruptcy is between $1,500 to $4,000 with lawyer’s fees starting in the thousands.
That cost is part of the reason I wanted to do this series with Upsolve. The app is totally free to use and lowers the cost to file bankruptcy to a few hundred versus the thousands you’ll pay using a lawyer.
When is Filing Bankruptcy a Good Idea?
So that’s really the basics of bankruptcy and we’ll get to those scenarios when to file but I don’t want you to think this is your only option. There are bankruptcy alternatives available though they have their own pros and cons.
Your first option is a debt settlement and I’m not talking about the debt settlement companies here. Yes, there are companies that offer to negotiate with credit cards and other creditors hoping to settle on paying less than you owe.
It sounds great but there are a lot of hidden dangers and huge fees with these companies. They’re going to first tell you to stop paying your bills so that gives them negotiating leverage with your creditors. This is going to destroy your credit worse than it is and go on for a year or two while you’re paying the debt settlement company thousands in fees.
Instead, I’m talking about a do-it-yourself settlement where you call up your creditors one-by-one and try to work out some kind of manageable payment play. You might be able to get the debt reduced if you pay the rest off in a lump sum or they might just put you on a longer-term payment plan you can afford.
Now if that doesn’t work, there’s also debt consolidation. This is where you take out one big loan to pay off a lot of your other high-interest debt. This might be a signature loan from your bank or maybe a personal loan online. The idea here is that if you can get a lower rate than your credit card or other high-interest debt, the money you save in interest helps to pay off the consolidation loan or you get a longer term that lowers your monthly payments.
Of course, the problem here is you’re not doing anything to actually lower the debt, you’re just moving it around from one creditor to another…and it’s likely that if you’re so far in debt then your credit score isn’t too great and you’re probably still looking at double-digit interest rates on a consolidation loan.
The final bankruptcy alternative we’ll look at before deciding when to file is credit counseling. And this is actually a good place to start because it’s going to explore all those options and you’re going to need to take a short online credit counseling course anyway before you file bankruptcy.
The credit counseling course takes less than an hour and Upsolve can show you how to get a waiver on the fee. Your financial counselor will look at your situation. They’ll explain things like debt negotiation, debt management and bankruptcy itself.
So we know what bankruptcy is and your alternatives, but when do you know if you should file? When is it time to start looking at filing bankruptcy?
Of course, one way is to speak with a credit counselor and you’ll need to do this if you end up filing anyway but I want to lay out three scenarios with some of the points when you might or might not want to declare bankruptcy.
Scenario one, let’s say Andy’s been out of work for months and has maxed out his credit cards. He’s got twenty grand in credit card debt and another five thousand in other loans. His credit score has already taken a huge hit, it’s under 600 FICO because of missed payments.
The only way Andy is able to keep up on his debt payments is by taking out more debt and it’s all high-interest because of his credit score. The calls from collectors are driving him crazy and he just feels trapped.
So I think it’s obvious, Andy needs a way out. He’s got more than $10,000 in dischargeable debt that he’s unable to pay. Keeping up with the debt is causing him a lot of stress and his credit sore is already destroyed from the experience. This is the textbook case of when most people would decide to file bankruptcy.
Our next scenario is Janelle. Now Janelle has actually gotten back to work but those bills really piled up while she was out of a job. She has some assets like a car and her home but her debts have mushroomed. Keeping up with her monthly payments is only possible by scraping the bottom of the barrel and it’s going to take six years to pay them off.
Janelle might not be as bad off as Andy but bankruptcy might still be something to consider. Even if you’re barely able to stay on top of your monthly payments, if it means living on nothing for more than five years, that’s more than anyone should have to go through.
Having some assets like a house and a car doesn’t disqualify you from bankruptcy either. In fact, in a 2019 study by the American Bankruptcy Institute on 488,000 bankruptcies, filers had an average of over $237,000 in debt and $171,000 in assets. The key here isn’t whether you have debt or assets but that the debt you owe is more than the value of your assets.
Our third scenario and let’s look at a situation where bankruptcy isn’t your best option. So meet Roger. Now Roger knows how bankruptcy can help because he filed and got his debts discharged about five years ago. He still owes quite a bit in student loans and some back child support though and would like to see that wiped out. The problem is, he’s also got some rental property and a few cars he doesn’t want to lose.
Now Roger wouldn’t be able to file anyway because it’s been less than eight years since his last bankruptcy discharge. Even if he could though, that student loan debt and domestic support is non-dischargeable anyway so he’s not getting out of it without paying. The trustee’s also probably going to look to take those rental properties and all but one car to help pay down debts.
Bankruptcy isn’t a last resort and it’s not the nuclear option that most people think. Check out that link to Upsolve to learn more and how to save on filing bankruptcy without a lawyer.