Should I File Bankruptcy? Pros, Cons and Alternatives

Key Takeaways

• Filing bankruptcy can help you eliminate debt, but it has serious consequences.
• Chapter 7 bankruptcy shows on your credit reports for up to 10 years and Chapter 13 shows for up to seven.
• You might not qualify for loans and credit cards for several years after you file bankruptcy.
• You’re required to complete bankruptcy counseling before you can file for bankruptcy.
• You can get your required bankruptcy counseling from an approved, NFCC-certified credit counseling agency.

Every year, more than 500,000 Americans file for bankruptcy. But is filing bankruptcy the best way to deal with debt? Many people come to us with this question, especially when they’re juggling multiple loan payments, growing credit card debt and other financial obligations. 

Filing bankruptcy is potentially a solution for overwhelming debt, since it gives you a legal pathway to a financial fresh start. But that doesn’t mean it is a perfect solution. One of the main drawbacks is that filing bankruptcy can do serious damage to your credit. Depending on what chapter of bankruptcy you file, you may also have to spend up to five years repaying some of your debt.  

Ultimately, if you’re considering bankruptcy, you should seek professional support to decide if it’s the right choice for you.

What is bankruptcy?

Bankruptcy is a legal process that can help eliminate some or all of your debt. Most individuals who file choose between these two types of bankruptcy:

• Chapter 7 bankruptcy: Eliminates most unsecured debt, meaning debt that doesn’t have collateral. This can include credit cards, medical debt and certain unpaid bills. In rare cases, some of your property (such as your vehicle) may be sold to pay back creditors. 
• Chapter 13: Puts you on a three- to five-year, court-ordered repayment plan for your debt. You can potentially include both unsecured debt (meaning accounts that are backed by collateral, such as car loans and mortgages) and secured debt in your payment plan.

These solutions may sound simple, but bankruptcy comes with several major drawbacks. There are strict eligibility requirements and fees that come with filing. Filing bankruptcy also leaves a long-lasting, negative mark on your credit reports.

What are the downsides of filing for bankruptcy?

You may want to consider filing bankruptcy if there’s no other way for you to pay back your debt. Filing can also help you if you need to stop lenders from foreclosing on your home or repossessing your car. But here are the drawbacks you should know about before proceeding.

Damage to your credit 

Chapter 7 bankruptcy stays on your credit reports for up to 10 years from the date you file, and Chapter 13 stays for up to seven years. You may be able to qualify for new credit within three- to five-years of filing, but you’ll likely pay higher interest rates.

With that said, a recent study from TransUnion found that filing bankruptcy can actually be less damaging to your credit than working with a for-profit debt settlement company. 

Creating a public record

Bankruptcy records are available to the public. So anyone who wants to can contact the court to verify that you’ve filed bankruptcy, and they can access information about your income, assets, and the debt that was included in the filing. Bankruptcy can also potentially show up on background checks.

Cost of filing

Lawyer’s fees can vary, and may run you anywhere from $1,000 to $3,000. You might be able to adequately represent yourself if you have a Chapter 7 case that’s relatively straightforward, meaning you have limited income and assets. However, it’s advisable to at least use guided support for this kind of filing, which you can get from a tool such as Upsolve.

Just keep in mind there’s always a risk that you could hurt your bankruptcy case if you file without legal representation. For example, you could end up missing a deadline or making an error in your paperwork. 

You also have to cover court fees to file for bankruptcy. For Chapter 7, the fee is $338 and for Chapter 13 it’s $313. Additionally, you have to complete pre-bankruptcy and post-bankruptcy counseling sessions with a court-approved counseling agency (see more on this below). Each session can cost up to $50. If you go through one of the approved NFCC-certified credit counseling agencies, fees will be closer to $15 to $25 per session, and income-based fee waivers may be available.

Potential loss of property

For Chapter 7, you’ll have a bankruptcy trustee assigned to you by the court after you file. Your trustee can potentially sell certain property to pay off your debt. In rare cases, this might include selling your home if you’re behind on your mortgage payments or if you have a lot of equity.

Strict eligibility requirements

In order to file Chapter 7, you may have to pass a “means test” to show that your income is low enough to qualify. If your income is too high, you may be able to file Chapter 13, which means you’ll have to pay back some of your debt. 

There are other eligibility requirements, too. For example, you generally can’t file Chapter 7 if you’ve already done so in the last eight years.

You may have better alternatives

Bankruptcy isn’t the only solution when you’re struggling with debt. Depending on your situation, there may be other options that are easier to qualify for, more affordable, or that don’t damage your credit scores as much. They may include: 

• Asking your creditors for hardship payment plans
• Enrolling in a debt management plan (DMP)
• Applying for an income-driven repayment (IDR) plan to reduce your federal student loan payments
• Taking out a personal loan to consolidate debt
• Working with an NFCC-certified credit counselor to adjust your budget or create a debt repayment strategy

How can a credit counselor help with debt and bankruptcy?

An NFCC-certified, nonprofit credit counselor can review your full financial situation and explain all of the available solutions for your debt. In fact, the American Bar Association recommends going through one of our agencies when you’re struggling with debt.

Here’s how a counselor can help you if your debt feels unmanageable.

A debt management plan (DMP)

NFCC-certified credit counseling agencies offer debt management plans (DMPs). For those who are eligible, a DMP can help you wrap multiple credit cards and other eligible debts into one monthly payment. These plans often give you access to lower interest rates and/or lower payments.

Debt settlement advice

If your debt is in collections, a nonprofit credit counselor can help you determine if it makes sense to negotiate debt settlements, and advise you how to go about it. They can also review your credit reports to help you better understand the details of what you owe.

Bankruptcy counseling

Before you can file for bankruptcy, you have to get pre-bankruptcy counseling from one of the U.S. Trustee’s approved counseling agencies. These sessions include working with a counselor who will help you create a budget and assess all of your debt repayment options. You’ll also have to complete a debtor education course after you file. 

Many NFCC-certified credit counseling agencies offer both of the required bankruptcy sessions. 

One important thing to keep in mind, however, is that credit counselors are not qualified to offer legal advice. If you’re seriously considering filing bankruptcy, the NFCC always advises seeking legal counsel in addition to working with a counselor.