Filing bankruptcy is much worse that it seems. Follow these six steps to avoid bankruptcy at all costs.
Filing for bankruptcy is pretty much a last resort when you absolutely cannot see any other way out of your financial problems and need a personal finance do-over. The problems caused by filing for Chapter 7 go way beyond just losing some of your current assets and can haunt you for years.
Doing everything you can to avoid bankruptcy before you make that leap could save you a lot of hardship down the road.
How Bad is Filing Bankruptcy?
Bankruptcy would be considered a nasty four-letter word if it weren’t so long. The most common form of personal bankruptcy, Chapter 7, uses your personal assets to pay debts and then clears most of the rest. It can seem like an easy solution to get out of debt but will appear on your credit report for up to ten years.
Having that bankruptcy on your credit report will make it nearly impossible to get any new loans for quite a while. The bankruptcy will destroy your credit score and some lenders won’t even consider you if you have a Chapter 7 on your report. If you are able to get a loan, you’ll pay thousands more on high interest rates.
You may even have trouble getting a job in certain sectors like banking or finance until the bankruptcy comes off your credit report. Sometimes there’s no way to avoid filing bankruptcy but making an effort will go a long way to keeping your finances in order.
6 Ways to Avoid Bankruptcy
Some of these six steps to avoid filing bankruptcy can be used together while others will work on their own. I’ve tried to arrange them from the best to worst in terms of effectiveness and financial hardship.
1) It all starts with laying everything out on the table. Look at your spending over the last three months. Track your spending down to the dollar and find exactly where your money has been going. Being able to pay your bills and avoid bankruptcy may be as simple as understanding which bills are really important, which bills you can cut and which ones you have to keep paying.
Try listing all your expenses by importance or need, without even thinking about the monthly cost. A lot of people have all kinds of little expenses, stuff that adds up to only $20 or so each month. It’s not really that important to them but they figure it doesn’t cost very much so why not pay it. This is going to be the best and first place to cut, all these little things that add up and end up breaking your budget.
We talked about one debt payoff trick in an earlier post on three credit score hacks to getting a loan. The debt snowball method is a great way to pay off your bills and stay motivated to keep on your budget. Instead of paying off the high-interest loans first, you arrange your debt by amount. You make the minimum payments on all bills but put any extra money to paying off your smallest debts first.
It’s great seeing debts drop off your list and it can be a great motivator to keep a budget.
2) If you still can’t pay your bills after cutting your monthly spending down to the bone, you’re going to have to sell some assets. If you file bankruptcy, you’re going to have to sell most of your possessions anyway so you might as well do it now and avoid bankruptcy.
Basically anything other than your home and one car is up for sale in a bankruptcy. If you’ve got a second car, you might be able to get a good price and wipe a lot of debts off your budget. How many TVs and computers do you really need? Do you have furniture in a room that you don’t even use? Check out this post for selling on Craigslist for how to get the most from your stuff and even how to make extra money on the site.
You might not get much for some of your stuff but just like cutting your budget, every little thing helps and can put you back on track and out of the way of Chapter 7.
3) Your third option to avoid bankruptcy is through a consolidation loan. This is where you take out an unsecured personal loan to pay off your other debts. You don’t have to pay off all your other debts with the consolidation loan but it helps to pay off any high-interest debt and to give you a little bit of a monthly cushion.
If you’re facing bankruptcy, your credit score probably isn’t great so check out these top 10 bad credit personal loan sites. You’ll need a higher credit score for a loan from p2p sites like SoFi but can get a loan from PersonalLoans with a much lower score.
I like PersonalLoans because there’s no origination fee so you don’t have to pay anything off the top and you can refinance later when you have a higher score for a lower interest rate.
Your consolidation loan will mean another bill each month so make sure you use it to pay off other debt. Since your loan is spread over three or five years, your monthly payments might be lower than your current debt and you’ll be saving money on interest.
4) If you have been paying your mortgage for a while, you may have equity that you can refinance or restructure. You won’t lose your home in a bankruptcy anyway but you might be able to lower your monthly payment or get enough cash out of your home equity to pay off other bills and get back on your feet.
5) If you’ve tried all the above steps and still don’t think you’ll be able to avoid bankruptcy, you might consider debt settlement. You’ll contact one of the debt companies for initial counseling and to work out a settlement plan.
Most of these debt settlement plans start by stopping all payments to creditors. The settlement company wants you to do this to give it more negotiating power with the creditors. It is going to destroy your credit score but you will be able to settle your debt for less than what you owe after a year or two.
Debt settlement looks bad on your credit report but it’s not quite as bad as a bankruptcy. Lenders will see that you tried paying off at least some of your debt which will make getting future loans a little easier.
6) This last step to avoid bankruptcy may be better than working with a debt settlement agency but it’s also harder to ask. Friends and family might be able to lend you the money to pay off some of your debts and avoid financial ruin.
This is a tricky one because destroying your relationship with family can be just as bad as destroying your credit. Make sure everyone involved knows whether it is a loan or money that doesn’t need to be repaid. If it is a loan, then do everything you can to repay it.
Filing bankruptcy may be the only solution if you’ve worked through these six steps and see no way to avoid Chapter 7. It’s also better than struggling for years and getting nowhere. Don’t think bankruptcy is an easy solution though and try everything you can to avoid it.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.