Should You Declare Bankruptcy? Here’s How to Decide

This post may contain affiliate links which may compensate us based on your interaction. Please read the disclosures for more information.

Deciding on bankruptcy is tough, but declaring bankruptcy can be a financial lifeline. Learn how to assess your situation here. [[{“value”:”

I used to be a bankruptcy lawyer, and I was often asked whether someone should file for bankruptcy. And even today, when people struggle to manage their budgets, it’s a question I still get from people who know of my previous expertise. And if you’re wondering about this, too, you’re not alone; almost 400,000 Americans filed bankruptcy in the last year of available stats (2022).

In all likelihood, if you’re like my former clients, you probably think of bankruptcy as the big, bad monster of your money movie. But what you should know is that, in reality, the bankruptcy monster is more like Sully in Monsters, Inc. rather than a Xenomorph in Alien.

Here’s why: Most areas of the law are about revenge. Criminal law is about putting people in jail, lawsuits are about extracting money. Even parking tickets are a form of punishment.

But not bankruptcy. Bankruptcy is about forgiveness. It’s about forgiving (most of) your debts and helping you get a fresh start.

Different, right? So, if you’re in financial trouble and are wondering if bankruptcy is right for you, let’s look and see.

Step 1: Assess your financial situation

Before considering bankruptcy, you obviously need to take a close look at your financial situation. Are you overwhelmed by debt due to unforeseen circumstances like losing a job, going through a divorce, or incurring medical expenses? If you’re finding it impossible to keep up with payments, bankruptcy might be a good option.

That said, you might want to first consider other options, such as negotiating with your creditors, exploring debt consolidation loans, or counseling with a nonprofit organization.

Step 2: Understand the different types of bankruptcy

There are three primary types of bankruptcy, but only two apply to consumers (Chapter 11 is for corporations).

Chapter 7 bankruptcy

This is the most favorable option if you qualify. With a Chapter 7, your unsecured debts — like credit card and medical debt — are completely wiped out. Secured debts, like car and home loans, can either be retained and re-upped or given back to the lender without paying any more.

The trick with Chapter 7 is that there is a limit on how much you can own and still qualify. It depends on your state, but for example, in Oregon, married homeowners can only protect up to $50,000 in home equity. If you own more than that, you would have to sell your home and let the bankruptcy trustee use the extra equity to repay your creditors.

Chapter 13 bankruptcy

This is a repayment plan spread over three to five years, where you pay back a portion of your debts based on your income. Unfortunately, many people struggle to complete their Chapter 13 plans because the repayment terms can be challenging.

But the good news here is that you can protect 100% of your home equity. If you don’t qualify for Chapter 7, this is often the next step.

Step 3: Determine if bankruptcy is right for you

Bankruptcy isn’t a solution for everyone. To decide if it is the right path for you, consider the following.

Debt relief

Can you eliminate enough debt through bankruptcy to justify the impact on your credit? Chapter 7 offers significant relief, but is sometimes harder to qualify for. Chapter 13 may help you manage your debt, but it’s a longer process with a lower success rate.

Asset protection

What assets are you willing to lose? Chapter 7 sometimes involves liquidating some assets, while Chapter 13 allows you to keep most assets while repaying creditors at least a portion of what you owe.

Future credit

How important is your credit score? Bankruptcy will whack your credit, but Chapter 7 may allow you to start rebuilding relatively quickly, while Chapter 13 will have longer-term effects. You could have a decent credit score (above 700) within two years after a Chapter 7.

Step 4: Consult a bankruptcy attorney

Given the complexities of bankruptcy laws, it’s crucial to consult with a bankruptcy attorney. They can help you understand whether you qualify for Chapter 7 or if Chapter 13 is more appropriate for your situation.

An attorney can also guide you through the process, ensuring that you meet all legal requirements and helping you create a plan that maximizes your chances of a successful outcome.

Step 5: Make your decision

Once you have thoroughly assessed your financial situation, understood the pros and cons of the bankruptcy options available, and consulted with a lawyer, it’s time to decide.

Bankruptcy is a serious step, but it can provide the relief you need to start over and rebuild your financial life. And if it works, who knows? Maybe you’ll be like my old clients who wrote me thank-you notes afterwards for helping relieve them of their stress.

Alert: highest cash back card we’ve seen now has 0% intro APR until nearly 2026

This credit card is not just good – it’s so exceptional that our experts use it personally. It features a 0% intro APR for 15 months, a cash back rate of up to 5%, and all somehow for no annual fee!

Click here to read our full review for free and apply in just 2 minutes.

We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.

“}]] Read More