When to Declare Bankruptcy (2024)

The right time to declare bankruptcy is usually after you have exhausted all your other options for meeting your financial obligations but you still cannot afford your debts. It might be time to declare bankruptcy, if, for example, you have large debts that you can’t repay, are behind in your mortgage payments and are in danger of foreclosure, or if you are getting calls from bill collectors.

Bankruptcy can often reduce or eliminate your debts, save your home and keep bill collectors at bay. But it also has serious financial consequences, including long-term damage to your credit score. That, in turn, can affect your ability to borrow in the future.

Types of Bankruptcy

Bankruptcy cases are handled by federal courts, and federal law defines six different types. The two most common types used by individuals are Chapter 7 and Chapter 13. Chapter 11 bankruptcy is primarily for businesses.

Chapter 7

Chapter 7 bankruptcy, the type most individuals file, is also referred to as a straight bankruptcy or liquidation. A trustee appointed by the court can sell some of your property and use the proceeds to partially repay your creditors, after which your debts are considered discharged.

Some types of property can be exempt from liquidation, subject to certain limits. Those include your car, your clothing, and household goods, the tools of your trade, pensions, and a portion of any equity you have in your home. You should list the property you are claiming as exempt when you file for bankruptcy.

Chapter 13

Chapter 13 bankruptcy results in a court-approved plan for you to repay all or part of your debts over a period of three to five years.

Some of your debts may also be discharged. Because it does not require liquidating your assets, a Chapter 13 bankruptcy can allow you to keep your home, as long as you continue to make the agreed-upon payments.

The Bankruptcy Filing Process

There are a number of steps involved in filing for bankruptcy. Failing to complete them can result in the dismissal of your case.

Before filing for bankruptcy, you are required to complete a credit counseling session. The counselor should review your personal situation, offer advice on budgeting and debt management, and discuss alternatives to bankruptcy.

Submit Financial Information

Filing for bankruptcy involves submitting a bankruptcy petition and financial statements showing your income, debts, and assets. You will also be required to submit a means test form, which determines whether your income is low enough for you to qualify for Chapter 7.

If you don't qualify for Chapter 7, you will have to file for Chapter 13 bankruptcy instead. You will also need to pay a filing fee, though it is sometimes waived if you can prove you can’t afford it.

You can obtain the forms you need from the bankruptcy court. If you engage the services of a bankruptcy lawyer, which is usually a good idea, they should also be able to provide them.

Connect with Bankruptcy Trustee

Once you have filed, the bankruptcy trustee assigned to your case will arrange for a meeting of creditors, also known as a 341 meeting for the section of the bankruptcy code where it is mandated. This is an opportunity for the people or businesses that you owe money to ask questions about your financial situation and your plans, if any, to repay them.

Your case will be decided by a bankruptcy judge, based on the information you have supplied. If the court determines that you have attempted to hide assets or committed other fraud, you may not only lose your case but also face criminal prosecution.

Debtor Education Course

After you have filed for bankruptcy—but before your debts can be discharged—you must take a debtor education course, which will provide advice on budgeting and money management. Again, you will need to obtain a certificate showing that you have participated. You can obtain a list of approved debtor education providers from the bankruptcy court or from theJustice Department.

Assuming the court decides in your favor, your debts will be discharged, in the case of Chapter 7. In Chapter 13, a repayment plan will be approved. Having debt discharged means that the creditor can no longer attempt to collect it from you.

Consequences of Bankruptcy

Bankruptcy has significant negative consequences on your credit history. A Chapter 7 bankruptcy will remain on your credit record for 10 years, while a Chapter 13 bankruptcy will generally remain for seven years.

There are also limits on how often you can have your debts discharged through bankruptcy. For example, if you have had debts discharged through a Chapter 7 bankruptcy, you must wait eight years before you can declare bankruptcy again.

Is a Lawyer Necessary?

You can file for bankruptcy without an attorney, which is called filling the case "pro se."

But because filing for bankruptcy is complex, and must be done correctly to succeed, it's generally unwise to attempt it without the help of an attorney experienced in bankruptcy proceedings.

Alternatives to Bankruptcy

Alternatives to bankruptcy can often reduce your debt obligations with less severe consequences to your credit history.

Negotiating with your creditors, without involving the courts, can sometimes benefit both sides.Rather than risk receiving nothing, a creditor might agree to a repayment schedule that reduces your debt or spreads your payments over a longer period of time.

If you are unable to make your mortgage payments, it's worth calling your loan servicer to find out what options you might have to avoid filing for bankruptcy. Those could include:

• Forbearance: allows you to stop making payments for a specified time, or a repayment plan designed to stretch smaller monthly payments over a longer period
• Loan modification: changes the terms of your loan (such as lowering the interest rate) on a permanent basis, making it easier to repay

If you owe money to the IRS, you may be eligible for an offer in compromise, allowing you to settle with the agency for an amount less than you owe. In some instances, the IRS also offers monthly payment plans for taxpayers who can’t pay their tax obligations all at once.

When to File for Bankruptcy

Bankruptcy law exists to help people who have taken on an unmanageable amount of debt—often as a result of large medical bills or other unexpected expenses. But it isn’t a simple process and it has negative consequences for your long-term finances.

Before filing for bankruptcy, explore all your alternatives and be prepared for the negative consequences. If you decide that bankruptcy is your only viable option, remember that your credit will take a hit for many years, but the negative consequences are not permanent.

The Bottom Line

Knowing when to file for bankruptcy is key to minimizing negative financial consequences. Filing for bankruptcy can cause significant harm to your credit history, however it can be the best solution for managing debt that you can't afford to pay.

Consider consulting with a reputable credit counselor to explain all your options for repayment before you file for bankruptcy.

By using credit carefully in the future and paying your bills on time, you can begin to rebuild your credit and gradually put bankruptcy behind you.