Bankruptcy is usually the last option people resort to when they’ve gone through a difficult financial situation. People often think that bankruptcy occurs due to a person’s financial irresponsibility or misuse of extended credit. But that’s not always the case.
People file for bankruptcy for numerous reasons. If you’re part of the reasons below and consider bankruptcy, there are several factors to consider.
We advise that you don’t take bankruptcy lightly as it comes with long-term consequences.
Top 5 Reasons Why People Go Bankrupt
- Medical expenses. A 2019 research published by the American Journal of Public Health showed that 66.5% of U.S. bankruptcies were because of medical issues.
- Job loss. Losing your income can be devastating, whether it’s a termination, layoff, or resignation. A study from Bankrate’s 2019 Financial Index Poll shows that three out of ten Americans don’t have emergency savings. And that can cause an individual to go into bankruptcy.
- Excess or poor use of credit. Some people can’t control their spending. As a result, credit card bills and other loan payments get out of control, and without any funds, bankruptcy is often the inevitable option.
- Divorce. Marital separation can cause financial strain on both partners in multiple ways. First, the legal fees alone can be too much to handle, and the legal costs can be enough to file for bankruptcy.
- Unexpected expenses. Some things are out of our control. When you’re not insured in any way, that can lead to bankruptcy.
You should take your time to understand the process, know all your bankruptcy alternatives, and make an informed decision. This article breaks down the vital things you need to know about various types of bankruptcies and several alternatives to consider. Let’s begin.
What Is Bankruptcy?
When you’re not able to pay back your outstanding debt, you’re considered bankrupt. Bankruptcy is a legal process carried out through the U.S. federal courts. During the procedure, federal bankruptcy judges make the final decision as to whether you qualify to file for bankruptcy or not.
Usually, bankruptcy is left for dire situations where a borrower is in extreme debt that they can’t overcome. For example, if you’re facing a foreclosure or can’t pay back your student loans due to undue hardships.
Now, you can discharge federal and private loans in bankruptcy. But keep in mind that it’s more complicated than paying off most other debts. Regardless, you can still get federal or private student loan debt relief via bankruptcy. But we recommend that you get an expert’s opinion before you proceed.
Different Types Of Bankruptcy?
There are different types of bankruptcies out there which you can file, and they largely depend on personal circumstances. But broadly speaking, bankruptcy can be grouped into two primary categories: Chapter 7 and Chapter 13 bankruptcy.
Let’s quickly go through them.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy, also referred to as liquidation or straight bankruptcy, is where you ask a bankruptcy court to eliminate most of your debts. That way, you can begin over. A judge will review your case and decide whether to accept the request or not.
If the court approves your request, they put an “automatic temporary stay” in place. That will stop your creditors from collecting their payments or, worse, take action against you, such as foreclosure, wage garnishment, or repossession, while the bankruptcy case is pending.
If you’re in serious student loan debt, Chapter 7 bankruptcy can give you immediate relief. But doing so comes with its downsides.
Filing for bankruptcy negatively affects your credit score for several years. On top of that, you could lose some non-exempt assets that are liquidated or sold to pay back your creditors. However, most assets are excluded and are not subject to liquidation.
Please note: your student loans, tax debt, including other types of secured debt, are not dischargeable. That means you must still repay them unless you can prove that you’re in an extraordinary situation.
Chapter 13 Bankruptcy
The Chapter 13 bankruptcy is less severe compared to Chapter 7 bankruptcy. It’s sometimes called wage earners or reorganization bankruptcy. Instead of paying off your debt by selling your property (like Chapter 7), you create and follow a repayment plan based on your immediate income.
If you have a steady income and massive debt and face pressure from your creditors, you can file Chapter 13 bankruptcy. That would help you reorganize your debt, so it becomes more manageable.
Keep in mind: you have three to five years to pay back any outstanding debt. And you’ll also have to submit what is called a repayment or reorganization plan.
Alternatives To The Types Of Bankruptcies
It can be a tough decision to file for bankruptcy or not. However, if you don’t know what to do, you can check out other options which may work in your favor. Some of the alternatives include:
- Debt Management Plans
Another way is to negotiate a debt management plan. With this plan, you make regular monthly payments to a company, and they make payments on your behalf to your loan creditors. The payment plan is tailored to fit your specific needs, which can offer some structure to your monthly payment process.
However, keep in mind that your loan lender is under no obligation to agree to the debt management plans.
- Debt Consolidation
When debt consolidation is done correctly, you combine all your outstanding loans into a single sum, which comes with a lower interest rate. It can help you manage your monthly payments as well.
Typically, debt consolidation is in the form of a loan, and the interest rates are usually lower than rates that come with individual companies.
But before you proceed, we recommend speaking to a student loan expert. That will help you make an informed decision that will benefit you for years to come.
- Debt Settlement
Debt settlement is an alternative to debt consolidation. With debt settlement, you make lump sum payments that are often less than what you currently owe. The amount is usually 50-75% of the original debt value.
Your credit report will usually show that you didn’t pay the agreed amount but paid less. And this will remain on your credit report for seven years, which can be a disadvantage to you because it’ll likely lower your credit score.
- Personal Loans
You can apply for a personal loan even if you have bad credit, but that will depend on the specifics of your circumstances. However, remember that the interest rates will be incredibly high, including the monthly payment.
So you’ll need to do your research to find out if it’s the right move. Seek an expert’s opinion before you proceed.
Final Thoughts
When it comes to bankruptcy, you must consider all the points outlined in this guide. Aside from that, you have to improve your financial situation, and you can do that by improving your money management skills, self-discipline, and mindset.
Try as much as possible to avoid debt when you complete the bankruptcy process. Learn to budget using various tools to assist you. It takes discipline, but the tools can make the journey easier.
Finally, build your emergency savings. There will be an emergency sometime in your life, and having a good emergency fund can help you immensely. You can start with $1,000, but you can increase to suit your situation.