What Is the Downside of Filing for Bankruptcy?
Objectively speaking, bankruptcy seems like a pretty sweet deal: you build up debt, you file with the court, and then they wipe that debt out. You basically get all of the stuff that you spent that money on for free, other than your time and the cost of filing (which are not insignificant, but probably less than your debt).
So, what is there to dissuade everyone from filing bankruptcy? While bankruptcy certainly has its benefits, there are some significant downsides to this drastic measure that should be considered before filing. A Chapter 13 filing, which makes up about a third of all filings, means you’ll still pay much of the debt back. And for the majority of filers – the Chapter 7s who walk away from much of the debt – there are still major downsides.
Like most court records, bankruptcy filings are a part of the public record. This means people can theoretically scrape the bankruptcy docket and know the name of every single person who files. Not many people do this, but it is certainly possible. It will likely show up on background checks as well.
This may be obvious, but if you file bankruptcy, it is going to go on your credit report. And it will stay there for many years – ten, for a Chapter 7 filing. Everyday things like credit card applications, applying for a home loan or student loans, will become significantly more difficult, or perhaps even for a short time, impossible. For example, many lenders will ask if you have filed for bankruptcy or been foreclosed upon within the last two or three years, before they will even consider you for financing. You will have to weigh that hurdle against the burden of your existing debt and bill collectors.
Eligibility Limits for Filing
The court is not going to grant everyone a reset button just because they have some debt. In order to file, you have to pass the eligibility Means Test. This test includes factors such as your assets, monthly living expenses, and especially your income. If you have a higher income, you may not be eligible for filing a Chapter 7 bankruptcy at all. Logically, this makes sense: the point of bankruptcy is to help people who are having trouble paying their debts to catch up financially. If you have a high income, you have a much easier time catching up to those debts.
Give Up Non-Essential Items
This may be the hardest part of filing for some people. You do not get to keep every personal possession when you file for bankruptcy. Items that are not considered essential by state law are subject to liquidation by the courts, meaning they will be sold and the proceeds will be applied to your debts. For one client, this meant choosing between a second work vehicle and a car that he inherited from a friend that he treasured dearly. (He chose the treasured vehicle, and purchased a cheap used truck for work after the proceedings were done.)
If you are concerned about particular assets, make a list of everything that you own that you care about, and compare that to your state’s exemptions list. Some states will allow you to keep two cars, some will only allow you to keep one. Some will give you a wildcard “keep any asset” exemption that is good for only one thing. And if you are at all in doubt, of course, consult with an attorney experienced in filing bankruptcies in your area about the assets that you are concerned about losing.
You’ll Need to Rebuild Your Credit
We touched on this a bit when we mentioned that you will lose out on some financial opportunities in the short-term, such as credit cards or obtaining a mortgage. In the longer term, you will have to work on rebuilding your credit if you want to have a better financial future. Bankruptcy severely harms your credit — there is no way around that. However, if your credit is already in shambles due to a lot of past due debt (the situation in which most bankruptcy filers find themselves before researching bankruptcy filings), you don’t really have anywhere to go but up.
Once you file bankruptcy, your credit will take a hit. But, by wiping out debt that you cannot pay, over the next couple of years of responsibly managing your finances, your credit will recover. In fact, it may recover even more quickly than it would have had you kept the past due debts on your ledger.