What is bankruptcy?

Filing for bankruptcy isn’t an easy choice to make, but for some people, it may be the best way to get out from under insurmountable debt related to medical bills, family emergencies, unemployment or overextended credit. It’s not a cure-all, though, and it’s a good idea to think of filing for bankruptcy as a last resort. Life after bankruptcy can be a long road to getting back on solid financial footing. 

That’s because bankruptcy can stay on credit reports for seven to 10 years, making it difficult to borrow money—and even impacting someone’s ability to rent an apartment or get new credit on favorable terms. 

Read on to learn more about how bankruptcy works and what you need to know if you’re considering filing for it.

Key takeaways

• Bankruptcy is a legal process that may bring some relief to individuals who are unable to pay their debts.
• A bankruptcy may remain on credit reports for seven to 10 years and might make it difficult to obtain financing in the future.
• Filing for bankruptcy involves submitting a petition and other forms with the bankruptcy court and completing credit counseling.
• U.S. courts strongly recommend consulting a qualified lawyer as part of the bankruptcy process.
• Not all debts can be forgiven through bankruptcy.

Filing for bankruptcy is a legal process that can help individuals remove or reorganize existing debts that they may not be able to repay. The two main types of bankruptcy that consumers can file are known as Chapter 7 and Chapter 13.

Filing for bankruptcy involves filing a petition with the bankruptcy court, typically with the help of a bankruptcy attorney. Keep in mind that bankruptcy laws differ from district to district, and it can be a complicated process. So if it’s something you’re considering, it’s a good idea to not only do your research but also get advice from a local attorney who specializes in bankruptcy law. 

Before filing for bankruptcy, an individual needs to complete a credit counseling program through an approved credit counselor. The counselor will review the individual’s finances and help them determine whether or not bankruptcy is the right option.

There are two main types of bankruptcy for individuals: 

• Chapter 7 bankruptcy: This is a quick, fresh-start option where almost all assets are taken and sold off to pay back creditors. Chapter 7 may allow individuals to keep their home or car if payments are kept current. But if they own a company or inherited a family home, those could be up for grabs. 
• Chapter 13 bankruptcy: This may be the best option for someone who has a regular income and property they want to keep. Individuals have a repayment plan, approved by the bankruptcy court, that enables them to pay off their debts over three to five years. 

While evaluating options, it may be a good idea to get advice from a local attorney who specializes in bankruptcy law.

Not all debts can be forgiven through bankruptcy. For example, the following debts are usually excluded from discharge in bankruptcy:

• Court-ordered alimony or child support
• Reaffirmed debt
• Most student loan debts 
• Fines, penalties or tax liens owed to the government
• Fines and penalties owed to a court

Filing for bankruptcy is a major decision, so it’s important to consider the downsides before filing.

Loss of property

With any chapter of bankruptcy, individuals may be required to give up their personal possessions to repay creditors. Property could include their home, vehicle or other valuable assets.

Damage to credit

Bankruptcy can also have a serious impact on credit. Because lenders view bankruptcy negatively, it could limit someone’s ability to apply for financing in the future. If they are approved for a loan, it’s likely they’ll have less-than-favorable terms and a higher interest rate. Depending on the type of bankruptcy, it could stay on credit reports for seven to 10 years.

It’s a good idea to think of filing for bankruptcy as a last resort. Individuals may want to first look into the following other steps to avoid having to file for bankruptcy: 

Talk to the lenders you owe

If you find yourself in financial distress, you could attempt to call your creditors, explain the situation and see what your options are. Creditors may be willing to negotiate a payment plan or offer help in other ways, like reducing the interest charges or waiving fees. 

Make a plan

A credit counselor might be able to help develop a repayment plan. You could find one through the National Foundation for Credit Counseling or the Financial Counseling Association of America. 

In addition to planning, a qualified counselor may be able to help negotiate smaller payments on  unsecured debt that’s not attached to collateral.

If you’ve filed for Chapter 7 or Chapter 13 bankruptcy, you’re probably already looking forward to putting it behind you. It won’t be easy, but these tips can help you stay the course: 

• Check your credit reports regularly. As past debts are taken off your reports, double-check your credit reports to make sure they’re accurate. You can get free copies of your credit reports from each of the three major credit bureaus at AnnualCreditReport.com.
• Rethink your financial habits. While it’s not always the case, if overspending was your culprit, you don’t want to make the same mistake twice. Start a budget and live within your means. 
• Save whenever you can. Build up an emergency fund to make sure you’re better prepared to handle emergencies and challenging times in the future. 

Bankruptcy is one route people can take to try to get a fresh start. But that doesn’t mean it’s easy or that there aren’t long-term considerations. That’s why the U.S. courts strongly recommend consulting a qualified lawyer as part of the bankruptcy process.

Want to consider other options? Read about tips for reducing or eliminating debt to get started.