What Happens If You Declare Bankruptcy

photo © 2008 Michael Coghlan | more info (via: Wylio)I just saw a commercial advocating bankruptcy as a good option if you are in trouble with your debts. That is misleading and far from the truth. The fact of the matter is that bankruptcy is a serious issue and can have serious implications that impact you for decades.

Debts Forgiven, Sort of

The reason many people think bankruptcy is a good idea is that their debts are forgiven. This is true to some extent, and the only tangible “benefit” of bankruptcy.

When you declare bankruptcy, a judge in bankruptcy court can reduce the debt you owe across the board. It is at the judge’s discretion how much your debt is lowered, if at all, and what the repayment terms will be.

You could have the majority of your debt wiped out, but you could have only a small portion. It is a big risk to declare bankruptcy and only have a small portion of your debt forgiven.

Either way, it is not a simple solution where you are off the hook. You are still liable for paying back something.

Credit Score

When you declare bankruptcy, your credit report will tell any creditor, landlord, or insurance company for seven years. If you are perfect from the bankruptcy going forward, everyone that matters still knows for nearly a decade.

The best way to kill a credit score overnight is a bankruptcy.

Future Loans

When your credit score goes down and your credit report shows a bankruptcy, you are going to have a difficult time getting new loans and credit cards. If you can get new credit, the interest rate will be much higher than someone without a bankruptcy on their record.

This is not a big deal if you are going to try to get a low limit credit card and pay it off in full every month, but if you get a mortgage loan, look out. The higher interest rate will cost you at least tens of thousands of dollars over the term of the loan.

Alternatives to Bankruptcy

The best way to avoid getting into bankruptcy is to avoid getting into a bad situation in the first place. Do not fill up your credit lines with stuff you can’t afford. Do not live above your means.

If you are already in trouble, work with the creditors to defer payments, lower interest rates, and come up with a plan to pay down your debt.

In my banking days, we would always try to work with people that called us and told us they were in trouble. We would come up with a payment plan that would not adversely impact their credit score. We would help them get into a better position. However, if you just stopped paying, we would report it to the credit bureaus, we would call and send collection notices, we would refer the debts to collection agencies or take legal action. It was not pleasant.

Your Stories

Have you ever been in bankruptcy? Have you ever had to work hard to avoid it? Please share your experiences in the comments.