US Bankruptcy Pros and Cons and Bankruptcy Alternatives
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For consumers who face mounting debts, bankruptcy can seem like a viable option. Although a bankruptcy declaration carries a significant stigma and can set back your finances, credit rating and personal affairs by years, there are plenty of reasons why you’d want to consider it. Despite reforms that have made the practice more difficult and restrictive, many thousands of Americans still file for bankruptcy in a typical year.
If you’re thinking about doing the same, it’s important that you get all the facts before making your decision. This article offers an incisive look at what bankruptcy actually entails, including a detailed accounting of its pros and cons. It also provides some insight on viable bankruptcy alternatives in the United States that might have a less dramatic effect on your credit rating and financial profile.
Bankruptcy in the USA: A Concise Definition
What exactly is bankruptcy? First, it’s important to note that both consumers and businesses can file for bankruptcy. Within these two broad categories, the U.S. Bankruptcy Code outlines several different types of filings. For consumers, the two most common types of bankruptcy are known by their entries in this Code: Chapter 7 and Chapter 13.
Broadly speaking, bankruptcy is designed to reduce or eliminate filers’ debts and make it easier for them to get their finances in order. The actual process is supervised by a bankruptcy judge and requires some input from each of the creditors with which the filer has had contact. Let’s take a closer look at the pros and cons of each common form of consumer bankruptcy.
Chapter 7 Basics
Chapter 7 bankruptcy is also known as “liquidation” or “straight bankruptcy.” Since it may involve the seizure or forfeiture of large amounts of personal property, it’s often regarded as a last resort by filers and their families.
When you file Chapter 7 bankruptcy, unsecured debts like credit card bills, medical bills and certain legal judgments may be forgiven. However, secured debts like car notes, special liens, student loans and other asset-tied obligations typically survive the process. To settle these debts, your bankruptcy judge may authorize the seizure of the assets to which they’re attached.
Once your debts have been forgiven or satisfied, the liquidation process concludes. However, you’ll continue to feel its effects for some time.
Chapter 7 Pros and Cons
Chapter 7 has a few key advantages. First, it’s designed to completely – or nearly completely – wipe away filers’ debts. When you file Chapter 7, virtually all of your unsecured debts will be forgiven. By forfeiting the assets to which they’re tied, you’ll also put your secured debts behind you.
While folks who file Chapter 7 risk losing the bulk of their personal property, state and federal governments provide “property exemptions” for assets that are deemed essential. Accordingly, a Chapter 7 bankruptcy filing won’t turn you into a pauper. You may be able to keep your retirement savings, some cash, part of your homestead and your family car. The exact exemptions that you’re able to claim will vary in accordance with state law.
If you’re willing to take responsibility for remaining current on your payments, you may also be able to “reaffirm” secured obligations like your mortgage and car note. In return, you’ll get to keep the pertinent assets.
Most importantly, Chapter 7 provides you with a “clean slate” that allows you to rebuild your financial life. This rebuilding process, however, can take years and may involve tremendous sacrifice.
Indeed, Chapter 7 comes with several key drawbacks. First, you’ll lose most or all of your non-essential assets, including potentially valuable collections, most of your non-retirement savings and real estate that can’t be exempted as part of your homestead.
Additionally, some of your obligations won’t be forgiven. If you owe spousal support, child support, student loans, property taxes and certain other debts, you’ll still be responsible for them after the discharge of your other debts. Worse, your Chapter 7 filing will remain on your credit report for a full decade. This can dramatically affect your ability to obtain credit, secure housing or even find suitable employment.
Finally, it’s critical to note that both forms of bankruptcy are matters of public record. Once you file, the details of your entire case, including potentially sensitive personal matters, will be available for anyone who wishes to review them. This includes future employers, recruiters, lenders and other important parties.
Chapter 13 Basics
Chapter 13 is the other common type of consumer bankruptcy. Also known as “reorganization,” it’s regarded as a “gentler” form of debt discharge than Chapter 7. That said, Chapter 13 is no laughing matter.
Unlike Chapter 7, Chapter 13 doesn’t provide for the wholesale forgiveness of unsecured obligations like outstanding credit card bills and hospital debts. Instead, it creates a framework through which these debts can be restructured and eventually paid off.
This demands the supervision of a bankruptcy judge and the agreement of each creditor. In a typical US bankruptcy case, credit card issuers might accept longer repayment windows, lower interest rates or reduced principal amounts in exchange for guaranteed payment. Meanwhile, secured debts generally remain untouched. Reorganization typically takes three to five years to complete and must begin within 45 days of the judge’s final approval.
Chapter 13 Pros and Cons
Reorganization’s biggest advantage may be the fact that it insulates the bulk of filers’ assets from seizure. Unlike liquidation, reorganization offers a clear second chance for borrowers who simply need more time or “breathing room” to manage their debts. Additionally, those who file for Chapter 13 bankruptcy may be able to pay off their credit card bills and other unsecured obligations for less than they originally owed.
On the other hand, reorganization presents some serious drawbacks. Like Chapter 7, Chapter 13 is a matter of public record and can seriously damage your credit score. Since it remains on your credit report for seven years, it can reduce the likelihood that you’ll be able to obtain credit during that time.
A Quick Note About Your Home And Refinancing
You may be eligible for a Home Affordable Refinance Program or HARP refinance program which will allow you to refinance your mortgage at a lower interest rate and reduce your monthly mortgage payment. This can free up some cash so you can better pay your bills and avoid having to think about bankruptcy at all.
Many consumers think about using the equity in their homes for a debt consolidation loan but there are a few drawbacks to doing this.
Debt Consolidation Loans: The Devil’s in the Details
Borrowers who don’t want to deal with a ravaged credit score or the loss of a significant portion of their assets may gravitate to a popular alternative: debt consolidation loans. These special loans are designed to pay off existing unsecured obligations, including credit card bills, immediately after they’re disbursed. In return, the borrower agrees to make regular monthly payments to their debt consolidation lender.
This sounds like a good deal, but the devil is in the details. If you miss a payment on your debt consolidation loan, your lender may place you in default. Naturally, this could have devastating impacts for your credit score.
Perhaps more importantly, debt consolidation loans aren’t available to everyone. Typically, lenders won’t extend these lifelines to borrowers who don’t have strong credit ratings. If your credit score is less than 620, it’ll be difficult for you to take out a debt consolidation loan without paying sky-high interest rates.
Debt Negotiation: A US Bankruptcy Alternative
Fortunately, there’s another US bankruptcy alternative that doesn’t come with a minimum credit score requirement: debt negotiation. Unlike bankruptcy, debt negotiation is never a matter of public record. Although it will temporarily affect your credit score like bankruptcy, the process won’t be “visible” to future employers, landlords or agencies that conduct background checks.
Functionally, debt negotiation is similar to Chapter 13 bankruptcy reorganization: It can reduce the total amount that you owe on unsecured debts like credit card bills, certain judgments, medical debts and more.
Unlike bankruptcy, however, it can take just two to four years to complete and doesn’t remain on your credit report for seven to 10 years. You also won’t have to worry about making multiple monthly payments to your creditors: The debt negotiation process consolidates your debts into an easy-to-manage monthly payment over which you have complete control.
Take the Next Step To Become Debt Free
Are you struggling with a difficult financial situation that shows no signs of improving? Don’t rush into the bankruptcy process before considering the alternatives that we’ve outlined here. To learn more about all of your debt relief options, including debt negotiation, navigate to our recommended bankruptcy alternatives company and fill out the free, no-obligation contact form. You can also call 888-339-3144 to speak with a debt negotiation expert.
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