Bankruptcy is a federal court process that places you under the protection of the bankruptcy court while you try to repay your debts (Chapter 13 bankruptcy) or removes the debts altogether (Chapter 7 bankruptcy). When you file for bankruptcy, an automatic stay goes into effect; the stay prohibits your creditors from attempting to collect the debt without the approval of the court, even if the bank is in the process of foreclosing on your house. Filing for Chapter 13 in this situation could buy you the time you need to sell the house yourself and pay off the mortgage.
Before you resort to bankruptcy, there may be things you can do to improve your situation. If your debt isn’t totally overwhelming, you may be able to cut back on nonessentials and find the money to apply to the debt. You may even want to sell your car or house and buy a less expensive one. If you haven’t taken advantage of the latest low mortgage rates, refinancing your mortgage (again) may net you a few hundred dollars a month that you could put toward your debt.
As a last resort, you could apply for a hardship withdrawal from your 401(k) plan if your plan allows them. The CARES Act expanded provisions for hardship withdrawals necessary due to COVID-19. If you’ve been affected by the virus, you can apply for a special hardship withdrawal of up to $100,000 without paying the normal 10 percent early withdrawal penalty. Other special COVID-related provisions include:
If you’re thinking about taking money out of your 401(k), contact a trusted financial advisor to help you work out the best way to do it.
Chapter 13 bankruptcy involves reorganization of your debts. You’ll need to file a proposal with the bankruptcy court detailing your plan for repayment and include a detailed budget, which could be challenged by the court if the judge, the trustee, or a creditor feels you’ve padded it with nonessentials. You’ll have to use all of your disposable income (any money left over after you pay for absolute necessities like power and water) to cover debt payments. If you want to spend money on anything else, you need permission from the court. If the court accepts your proposal, it may garnish your wages during the repayment period, which usually lasts three to five years. In Chapter 13 bankruptcy, you can prevent the loss of your home by immediately starting to make your regular mortgage payments and any catch-up payments required by your repayment plan.
Before you make the decision to file for bankruptcy, you should know which debts you may be able to walk away from and which you’ll still be responsible for. Debts that can’t be discharged or forgiven include:
Harder to File Bankruptcy
In 2005, Congress drastically changed the bankruptcy system. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 passed, which made it more difficult for individuals to seek shelter in bankruptcy. Among other changes, it has become harder to qualify for Chapter 7, and financial counseling sessions are required.
Because repayment of some of your debts is the basis for this type of bankruptcy, you have to have enough regular income to cover the monthly payments. Regular income can include Social Security benefits, childcare or alimony, and rental income, and, of course, employment or self-employment wages. You also have to be up-to-date on your income tax filings. You also can’t exceed the current Chapter 13 debt limitations, which change every three years. For 2020, the limitations are $1,257,850 of secured debt and $419,275 of unsecured debt.
Under Chapter 7, liquidation, you turn most of your personal property over to the court, which appoints a trustee to sell the property and use the proceeds to pay off all or some of your debts. You may be allowed to keep certain exempt property (such as your house or your car), but that depends partly on your home state, your equity in the property, and whether you’re current on the payments. This entire process takes about six months to complete. At the end, all of your debts will be fully discharged except for a few types that remain on the books (more on that in a minute).
After the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Chapter 7 bankruptcy became difficult to qualify for. Now, if the court determines that you have enough disposable income, you’ll be required to file a Chapter 13 bankruptcy instead. You also may not be eligible to file Chapter 7 if you’ve previously filed for bankruptcy within the past six to eight years.
Chapter 7 might be a good option if you have a lot of credit card or other unsecured debt, few assets, and low income. Talk with a credit counselor and an experienced bankruptcy attorney before taking this step; there may be other ways to handle your debts that will give you more control over your situation.
Some debts, such as child support and taxes owed, cannot be erased by bankruptcy. In most—but not all—cases, student loan debt will not be discharged under Chapter 7. In addition, you will almost certainly be held responsible for debts challenged by your creditors.
These include:
You will also remain responsible for any debts you don’t list in your court filing, so if you go this route, make sure to include every debt you have when you fill out the paperwork.
Chapter 7 bankruptcy stays on your credit report for up to ten years from the day you file. During that period, you may be denied credit or charged higher rates for loans or credit cards. Using credit responsibly moving forward can help rebuild your credit, but that won’t happen overnight. Use care when taking on new debt, and make sure you can afford to make every payment on time.
If you filed for bankruptcy because of irresponsible money management, it won’t help you in the long run if you don’t change your spending habits. On the other hand, if your bankruptcy was caused by job loss, high medical bills, disability, death, divorce, or other circumstances not entirely in your control, filing may give you a fresh start. If you file for bankruptcy, the court will place restrictions on how you can spend money and will not allow you to buy what it considers nonessentials.
Chapter 13 bankruptcy can actually help you learn financial discipline that may prevent you from ending up in the same situation again, because you’ll live under a strict budget for the entire repayment period, which is typically between three and five years.
The ten-year period following the filing of bankruptcy may be difficult, as the bankruptcy follows you around whenever you apply for credit or even sometimes when you apply for a job.
Be aware that there are many disreputable people who call themselves credit counselors but who really just prey on desperate people. Do plenty of research to make sure you’re dealing with a reputable company before you hand over any personal information or sign anything. It can sometimes be hard to tell the good guys from the bad guys in the credit counseling universe. Avoid any companies that:
If you notice even one of these red flags, do not work with that company.
You’re in debt up to your ears, the debt collectors are hounding you every time you turn around, you can’t get any new credit, and along comes a credit repair clinic that promises to clean up your credit history in days. Doesn’t it sound too good to be true? If someone says that you can improve your credit score overnight, it’s a scam. Repairing poor credit isn’t quick and easy. Anyone who promises you that it can be is lying.
Avoid working with anyone who offers up any of these as a poor credit solution:
The truth is that the only way to repair poor credit and increase your credit score is by paying down your debt and developing good financial habits. Anyone who tells you otherwise is scamming you.
When you’re in an immediate financial fix, a payday loan can seem like a lifeline, but that financial “rescue” comes at a very steep cost. These loans come with extremely high interest rates—the annual percentage rates (APRs) can come close to 400 percent!—that can pull you into a dangerous cycle of needing to borrow more just to get by.
Here’s how it works. In exchange for a postdated personal check or an authorization to directly pull money from your checking account, a payday lender essentially gives you an advance on your next paycheck that has to be paid back right away (usually no longer than two weeks). For this convenience, the lender charges you a fee for every $100 borrowed. The way they word it makes it seem as if you’re not paying a crazy amount, just $10 or $15 per $100. But it really takes a much bigger toll on your finances.
If the lender charges you $15 for every $100 you borrow, that seems like a 15 percent interest rate. But because the loan has to be paid back in two weeks, the APR is really 390 percent (15 percent divided by 2 weeks times 52 weeks). In comparison, even the highest-rate credit cards don’t have triple-digit APRs—and that’s part of what makes payday loans so toxic to your finances.
Current Scams
The FTC’s website at www.ftc.gov lists current scams and unscrupulous schemes. Before you get involved in anything that sounds too good to be true, check it out with the FTC or one of the consumer groups online that monitor fraud.
Since you have to pay the lender back when you get your paycheck, you won’t be able to use that paycheck to cover your expenses, which forces you into taking another payday loan. If you can’t pay it back, the lender can get a judgment against you and garnish your wages. Breaking the cycle can be very hard, and the only way to get out is to stop borrowing money this way. You’ll need to find other ways to get your hands on cash even if it means borrowing from family.