Thinking About Filing for Bankruptcy? It’s Worth Considering If You Have This Much Debt, Experts Say
Written by
Hanna Horvath
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Cory Dudak
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Bankruptcy filings have increased more than 12% in the past year. If you feel like you’re drowning in debt and don’t know a way out, bankruptcy is one option. But how do you know if you should file?
Bankruptcy often has a bad reputation, and filing has definite downsides. But depending on the size of your debt, bankruptcy can be a lifeline to helping you get back on your feet.
Here’s how much debt you should have before you start considering filing for bankruptcy.
Understanding Bankruptcy
Filing for bankruptcy can reduce (or even eliminate) the debt you owe, providing relief from your creditors and immediate repayment obligations.
Debts that can be discharged in bankruptcy include medical debt, credit card debt, car loans, personal loans, payday loans, utility bills, and any other unsecured debts.
Remember that some types of debt, like student loans or tax debt, do not get discharged in bankruptcy. If you’re struggling with other types of debt, you may want to seek other alternatives.
There are two main types of bankruptcy for consumers: Chapter 7 bankruptcy and Chapter 13 bankruptcy.
Chapter 7 bankruptcy, or liquidation bankruptcy, is available to individuals who can’t pay off their unsecured debt, like credit card bills or personal loans. When you file for Chapter 7 bankruptcy, many of your assets (like your home or car) are sold to pay off as much of your debt as possible. The rest of your debt is then discharged.
Chapter 13 bankruptcy, known as reorganization bankruptcy, allows you to retain some of your assets while paying back your creditors over a set period of time, typically a three-to-five-year period. This type of bankruptcy is typically available to those who earn a steady income and can make regular monthly payments over time.
Despite this, bankruptcy doesn’t mean just offloading your debt and walking away scott-free. It can be detrimental to your finances and negatively affect your credit in the long term. It should be seen as a last resort when you have so much debt you’re unable to handle the payments.
Evaluating Your Total Debt Situation
There is no minimum amount required to file for bankruptcy. However, a standard guideline is that $10,000 or more in debt is enough to consider filing.
This is because filing for bankruptcy costs money, and if you have a smaller debt, it may not be worth the effort and fees. Most bankruptcy lawyers won’t take on your case unless you have at least $10,000 in dischargeable debt.
Filing also depends on your current income.
Chapter 7 is the more advantageous type of bankruptcy because it costs less to file and allows you to eliminate your debt, no matter how much you owe.
However, to file for Chapter 7 bankruptcy, you’ll need to pass the Chapter 7 means test. This test looks at the last six months of your disposable income to determine if you can afford to pay your bills. The less money you make, the more your case will likely go forward, and your debt can be discharged. You’ll typically need to make less than your state’s median income to qualify.
What to Consider Before You File For Bankruptcy
If you have an unmanageable debt, bankruptcy can be a fresh start. It allows you to discharge some of your debts and help you start building smarter financial habits.
But filing for bankruptcy can be a long, expensive process, so it should be one of the last things to consider if you have debt.
For one, it does cost money to file. You’ll often need to pay court fees, filing fees, and attorney fees, which can range anywhere from a few hundred dollars to a few thousand dollars.
The most damaging consequence of bankruptcy is its impact on your credit score. Depending on your score before you file, it could drop as much as 150 points or more and stay on your credit report for up to 10 years.
Building up your credit score after bankruptcy will take time and effort. It will also be more challenging to access some loans or credit cards with a lower score, or you may only have access to loans with higher interest rates. Plus, many landlords and employers will check your credit score before offering you an apartment or job — a lower score could hurt your chances.
Plus, while bankruptcy can alleviate the problem, it doesn’t always address what got you into debt in the first place. Making sure you have a plan to avoid overspending or racking up more debt is the key to never having to consider bankruptcy again.
Alternatives to Bankruptcy
If you want to avoid filing for bankruptcy but get a better handle on your debt, you have some options. Alternatives to bankruptcy include debt consolidation loans, debt settlement or debt relief, or trying to pay it back on your own.
If you have a smaller debt (like a few thousand dollars), you may be able to tackle it on your own with a solid repayment plan. One popular debt payoff method is the avalanche strategy, which has you pay the debt with the highest interest rate first and work down to the one with the lowest rate while making sure to make the minimum payments on your other debts.
This strategy will save you the most money in interest in the long run.
If you only have credit card debt and it’s somewhat manageable, consider transferring it to a balance transfer credit card, which offers a period of zero interest for often up to 21 months. You can use that time to pay down your balance without accruing more interest, but keep in mind that once that promotional period is over, you’ll face steep interest rates.
You may also be able to afford bankruptcy through a debt consolidation loan, which combines your debts into one loan with a fixed monthly payment. Typically, this move will lower the interest you pay and make it easier to manage your payments. But this strategy doesn’t eliminate your debt, so you’ll still need a solid plan to pay it off.
Lastly, consider hiring a debt settlement company to lower your debt by negotiating with creditors. You’ll typically need a higher debt (around $10,000 or more) and should consider this option after the ones above. Knowing who you’re doing business with is also important — some debt relief companies can be predatory and charge exorbitant fees.
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