Reasons to Avoid Bankruptcy
Why You Should Stay Away from Bankruptcy & Choose Alternatives
Jun 8, 2009
Recently, the number of bankruptcy petitions has been on the rise. The high unemployment rate coupled with a pervasive credit meltdown has taken the stigma out of bankruptcy and has instead positioned it in the public psyche as a more acceptable part of life. The truth is, however, that bankruptcy is something to avoid where ever possible. There are many serious consequences to filing for bankruptcy, and consumers should be well informed before making such a decision.
What is Bankruptcy?
Bankruptcy law was established to help financially distressed businesses and individuals by eliminating and/or restructuring high levels of debt. There are two major ways for individuals to file for bankruptcy, Chapter 7 or Chapter 13, and each one has very different terms, procedures, and consequences.
Under Chapter 7, also known as "liquidation bankruptcy," an administrator or trustee is appointed to sell off the individual's personal property so that the outstanding debts can be repaid to the fullest extent possible. Some personal assets, such as personal residence and disability benefits, may be exempt from the liquidation, but state and federal laws vary in this area. The portion of the debt that cannot be repaid through the asset liquidation is then discharged.
Unlike Chapter 7, a Chapter 13 filing will not eliminate an individual's debt, but the filer can keep personal assets. With Chapter 13, filers must set up a three-to-five year plan to repay their creditors. According to the Bankruptcy Reform Act of 2005, any individuals with an income above the state median will have to file for Chapter 13 and pay back at least a portion of their debts.
Reasons to Avoid Bankruptcy
There are many reasons to stay away from bankruptcy, namely:
- It tarnishes the filer's creditworthiness and will adversely effect finances. A Chapter 7 bankruptcy appears on a credit report for10 years, while a Chapter 13 bankruptcy will be noted for 7 years, making it difficult to obtain mortgages, credit cards, and various secured and unsecured loans. Moreover, one should keep in mind that many loan applications and job applications require applicants to state if they have ever filed for bankruptcy.
- Not all debts can be discharged. Certain debts, such as alimony, child support, property settlements, criminal judgments and fines, student loans, and taxes, will not be discharged when filing for bankruptcy.
- One can lose property. Under Chapter 7, all non-exempt assets may be sold off to cover outstanding debts. Moreover, should the filer not make a significant attempt to pay off the debt, creditors may be able to repossess or foreclose a property that they hold a lien on.
- Recent legislation has made filing for bankruptcy more difficult. After the Bankruptcy Reform Act of 2005 was passed it became harder for individuals to qualify for Chapter 7 bankruptcy, and the list of non-dischargeable debts was expanded. Other actions included limiting a filer's protection from collection agencies and requiring that filers receive credit counseling in addition to instruction on financial management at their own expense.
- Not all retirement account assets are protected. Bankruptcy laws protect qualified retirement accounts, such as a 401k account and up to $1 million in an IRA account. But any funds that exceed the IRA account limit may be used to pay down debts.
How to Avoid Bankruptcy
Depending on the circumstances, there are several ways to avoid the difficulties of bankruptcy:
- Negotiate a payment plan with creditors. Try to negotiate with creditors or collection agencies in order to reduce the amount of debt. Creditors may cut down the debt by 40-60% in the hopes of receiving at least a portion of the money owed rather than losing out completely. Negotiations can be done alone or with the help of a qualified professional.
- Enroll in a debt consolidation program. With debt consolidation, bills are consolidated into one easy monthly payment. Moreover, late fees and over-the-limit charges on credit card debt are also eliminated.
- Enroll in a debt management program. With this option, a credit counseling agency provides a plan to keep the debtor current on bill payments in an effort to reduce interest rates and late payment fees.
- Take advantage of free credit counseling. There are several organizations that offer free or low-cost credit counseling services and debt reduction material, such as the National Foundation for Credit Counseling, Myvesta.org, and The Institute of Consumer Financial Education.
- Learn how to budget. Being on top of monthly income and expenses plays a fundamental role in avoiding bankruptcy.
Be aware that bankruptcy would be appropriate in situations where all attempts to negotiate payments with creditors have failed or where the ratio of debt to annual income is over 40%. Otherwise, people would be wise to do all they could to avoid the financial hardships that bankruptcy brings.
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