No one wants to go bankrupt, but when you get in over your head and can’t see a way out, sometimes there is no choice. Bankruptcy is a process where the federal courts allow you to reduce or eliminate your personal or business debts. However, filing for bankruptcy can have long term effects on your credit report and many people don’t really understand how Bankruptcy works.
What is Bankruptcy and How Does It Work?
Bankruptcy is a long and complicated process, and it is best to hire an attorney to help you through it. The first item is you must prove unequivocally that you cannot repay your debts. You may also have to complete credit counseling with a government-appointed credit counselor. During this part of the process, you might find alternatives to bankruptcy, and the counselor will help you work out a personal budget plan to repay your debts.
The next step in the process is to decide which type of bankruptcy to file. You can choose Chapter 7 or Chapter 13. Both types will help you avoid foreclosure, eliminate your debts, and stop debt collection, wage garnishments, and utility shut-offs, but there are some differences too.
What is a Chapter 7 Bankruptcy: What Happens When You File it
Chapter 7, bankruptcy is the most common type used by individuals. It is also called “straight bankruptcy.” With a Chapter 7 bankruptcy, you are appointed a federal court trustee who oversees the sale of your property. You may be allowed to keep some personal belongings and your car as well.
How Long Does Chapter 7 Stay on Credit Report
The proceeds of the sale go to paying back your creditors, and the rest of the debt is discharged. However, with Chapter 7, you still have to pay things like student loans, alimony, child support, and taxes. The negative impact of filing for Chapter 7 is immense as it stays on consumers' credit reports for 10 years. Plus, if you get into trouble again, you cannot file for Chapter 7 again for eight years.
What is a Chapter 13 Bankruptcy?
With Chapter 13 bankruptcy, you don’t have to sell your home, but in exchange, you will have to repay some of your debt. The courts allow your attorney to negotiate either a three or five-year repayment plan. After the repayment plan has ended and you paid the portion that you agreed to, the rest of your debt is discharged. Because you pay back some of your debt, this may be a better option for some. In addition, you get to keep your home, and if you need to, you can file Chapter 13 again after only two years.
How Long Does Chapter 13 Stay on Credit Report
With Chapter 13, the bankruptcy may only stay on the credit report for seven years, but that is still a long time to carry the stain of bankruptcy on your credit. Plus, if someone cosigned a loan for you, they may now be responsible for that debt.
What is the Effect on Your Credit?
There are a lot of negative consequences of filing for bankruptcy. With Chapter 7, you can lose your house, your cars, jewelry, and other family heirlooms. Plus, Chapter 7 stays on your credit report for ten years!
What Will the Credit Score Be After Chapter 7
Filing for bankruptcy can drop your credit score by 200 points overnight. Lenders may not extend you any new credit because of it. You might have trouble getting credit cards, auto loans, and another financing for years. If you are able to get financed, you will probably have to pay higher fees and higher interest rates. It is near impossible to apply for and get approved for a mortgage until the bankruptcy cycles off your credit report.
Even though the balances show as “discharged,” they will still show up on your credit report as a debt that was affected by bankruptcy.
How to Avoid Bankruptcy
When you feel the pressure bearing down on you from your overwhelming debts, bankruptcy may seem like a quick fix, but it might be better to pause and look at alternative options. Although you might suffer some short-term adverse effects, your credit may be better in the long run. Some alternatives to bankruptcy are:
- Credit counseling - you can request a government-appointment credit counselor to help you sort things out. They are professionals and might think of solutions you haven’t even considered.
- Debt consolidation - banks offer consolidation loans that pay off your high-interest debts and combine them into one, low-interest, affordable monthly payment. This option can be a lifesaver for some people and certain situations.
- Debt management - you can hire a professional debt management agency or contact your lenders yourself to negotiate better interest rates and terms. Rather than have their account discharged in a bankruptcy, they may be willing to work with you so that they eventually get paid.
Remember though; if you fail to pay your debts on time (even during negotiation of a better situation), your credit rating may suffer. These options, however, could be a better fit for some. Your credit score may rebound much quicker from the effects of a few late payments rather than a catastrophic bankruptcy.