Bankruptcy: a dreaded term, something many astute and responsible people fear. For many Americans, bankruptcy is their only legal way out of a bad situation. I’ve done it. It is likely something someone in your family has done. Several well-known celebrities have done it. I will tell you why I filed bankruptcy a few years ago, but first let’s understand what bankruptcy is.
What is Bankruptcy?
Let’s first talk about what bankruptcy is not. Bankruptcy is not a get out of jail free card on your debts. It can cause substantial damage to your credit rating. If you are not someone who knows how to develop credit rebuilding strategies to over come that damage, then filing could be detrimental to you. Here is what bankruptcy is not:
Get out of debt pass
Bankruptcy is not meant for you to get out of debt simply because you don’t want to pay your obligations anymore. Instead, it is a tool for people who have more debt than they have the ability to pay for the debt. A decision to enter into bankruptcy should be strategic with a consideration for the costs that are connected to it.
Determination of Your Character
Okay, so you have to file bankruptcy. Big deal. It is a stressful time because you have to gather so much information, take credit classes, pay money and such. It can be a stressful time, but do not allow the reputation concerning bankruptcy to stop you from doing what you need to do for yourself or for your family. Again, count up the costs and weigh the pros and cons for your situation.
End Your Ability to Get Credit
Many think that once you have filed bankruptcy, it means that you won’t ever be able to get credit again and if you do, the interest rates will be outrageous. This is true to a certain extent, but if you play your cards right, you can circumvent a lot of those road blocks. If you’ve read my article about rebuilding credit, I mention a few tools to use to rebuild credit, even if you have filed bankruptcy.
Using Bankruptcy as a Tool
Now we get into what Bankruptcy is and what it can do for you. Bankruptcy is a legal process that alleviate debt pressures from citizens and businesses that are cash-strapped and unable to pay their debt obligations. The history of the US Bankruptcy laws is quite complicated, but fast forward to today, the laws allows for citizens within reason to alleviate their debts, but harsher qualifications are now imposed.
If you file for bankruptcy, there is a thorough vetting of all of your assets and your debt. Your income is included in this factor through what’s called a means test. The means test measures whether you should be able to pay your debts based on your adjusted gross income. This stops those who are well off from filing bankruptcy when in fact their income determines they can at minimal afford a repayment plan. Consult with a bankruptcy attorney to get clarity on the process.
Main Two Types of Filings
Chapter 7
A chapter 7 bankruptcy is when all qualified debts are discharged (forgiven) and you move forward without any future obligations to the debt. The chapter 7 involves the thorough vetting process I mentioned. The bankruptcy court will want to ensure that you are truly in a bankrupt situation.
Chapter 11
A chapter 11 bankruptcy is when your qualified debts are consolidated into a payment plan where you pay back the debt you owe. It is not nearly as simple as I have just stated, but the gist of it is that it’s a payment plan for your debts. Some opt to go this route either because they could not pass the means test due to their income or because they do not want the stigma of filing chapter 7.
Some feel better about themselves because they were still able to pay back a portion or most of their debts. Chapter 11 is not the golden boy option over chapter 7. It’s just another option for you to consider if you are able to file either chapter 7 or chapter 11. You should consult with your attorney on which may be best for you.
Both chapter 7 and chapter 11 will damage your credit rating severely. A chapter 7 is expected to stay on your credit report for about 10 years while a chapter 11 may be removed after 7 years. This is also another reason why some opt for chapter 11 over chapter 7.
Why Did I File and Which Did I Choose
I’ve been working since I was 16, and from that time up until the economic failure in 2008, I enjoyed steady work, a growing career and opportunities to establish credit. The ambitious, get it done, person you see today is who I was then. When the recession came, I lost job after job after job. All of these job loses put me in positions where I defaulted on credit obligations. I also had medical bills that had stacked up as well due to high deductible plans and out of pocket expenses.
At first, I decided to try and manage my debt on my own, develop my own payment structures and try to do what I could. A salary of around $35k a year at the time was not enough to pay down debts and maintain paying my living expenses. This is a prime circumstance for being in a bankrupt situation.
I made several decisions to better my situation which included moving to Atlanta to take a higher paying job, forecasting my earning potential by leveraging my education goals and goals for future promotions. And, I also came to a decision to file chapter 7 to put away years of debt from credit cards, car loans, and the alike.
The decision included voluntarily downsizing my car, putting myself on a budget and following a strategy to rebuild. At the same time, I progressed in my career tenaciously and amassed an income that increased my cash flow to be able to manage debt post-bankruptcy.
Was it Worth It?
For me, yes, it was worth it. Bankruptcy is designed for people like me, like you, and like your parents. Financial situations due to a job loss, a divorce, or a change in the economy is likely why we had to file. I had to take a deep breath one day and tell myself to be okay with doing something about what I was not able to do something about with the amount of income I had.
Here are the pros and the cons for me:
Pros
- The ability to start over and free up the money I was paying debt with to now comfortably pay student loans and other obligations.
- An awareness of my spending, savings, and credit habits. The process teaches you to budget and be aware of your budgets
- Learning about credit tools to rebuild
- Learning that I am strong enough and humble enough to “do what I have to do” for myself
Cons
- The damage to your credit profile. My score dropped to 460 when it was already low due to the bad trade lines on my credit
- The stress in going through the process if you are not mentally prepared.
- Not being able to buy a house for at least 2 – 3 years post bankruptcy.
Typically, you hear cons listed like you can’t get credit, or you’ll experience very high interest rates. This is true like I said to certain extent, but really, it depends on you.
My first post-bankruptcy car loan interest rate was 12%. That’s not too bad for post bankruptcy, but not ideal by the least bit. But, I do know the worst of car APRs can be upwards 25%. I kept the car for a year, and then traded out and ended up with 3.2%.
I took out a couple of secured credit cards with pretty decent interest rates. 6-12 months of using these increased my ability to secure an unsecured Discover card.
700+ Club 3 Years After Bankruptcy
Sure, the bankruptcy will stay on a credit file for several years, but this is where rebuilding comes in. The older the bankruptcy becomes, the less of an impact it has, and also, if you are adding positive activity to your report, it offsets the damage of the bankruptcy. It is very plausible to achieve a credit score well above 700 within a couple of years of filing bankruptcy. You must do the work though, and leverage your income.
It took me 3 years because I was not as aggressive as I could have been, but 2 years is a very real possibility for most who file bankruptcy. You must learn how credit works and then use it to work for you. I made it work for me by starting out with secured credit options through the recommendations I’ve mentioned before.
Once those options graduated to unsecured options, I managed those the best I could and landed in the sought after 700+ club. Keep in the mind, the presence of the bankruptcy will always suppress your credit score, but the older it becomes, the less of an impact it has. Achieving a 700 or even an 800+ credit score post bankruptcy is within reach.