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Why Borrowers Should Wait Before Jumping into Bankruptcy

There’s a scene in the American version of The Office where boss Michael Scott tries to make his money problems disappear by yelling, “I declare bankruptcy!” This outburst follows another character, Creed Bratton, offering the faulty advice that bankruptcy is “nature’s do-over” and a “clean slate.”

The scene is humorous but filing for bankruptcy is a very serious decision that will affect your credit report for years to come — seven or 10 years, depending on the type. As tempting as it can be to think about your debts simply vanishing, there’s a lot more to the process than that.

Here’s why borrowers should wait before jumping into bankruptcy.

The Consequences of Bankruptcy

There are two types of bankruptcy individuals may file: Chapter 7 or Chapter 13.

The former is known as “liquidation” because the court may require you to sell off certain assets and use the funds to pay back some of what you owe to creditors before considering your debts discharged. The latter is known as “repayment” because you’ll emerge with a partial or full payment plan, usually spanning three to five years, after which those debts will be discharged. While you could have to sell your home — and other assets — under Chapter 7 bankruptcy, you’ll get to keep these assets as long as you adhere to that payment plan under Chapter 13.

Chapter 7 bankruptcy can remain on your credit report for up to 10 years; Chapter 13 can stick around on your credit history for up to seven years. Lenders, of course, can see this — which may in turn influence what credit you can get and what interest rates you’ll pay for years to come.

To recap:

  • You may lose property like real estate, vehicles, furniture, and possessions of value.
  • Your credit score will sustain damage.
  • Your credit report can contain evidence of bankruptcy for seven to 10 years.
  • It will be more difficult to secure credit after filing for bankruptcy, and you will likely have to pay more in interest charges.

Options Worth Exploring Before Bankruptcy

After reading through the consequences of bankruptcy, it’s easy to see the reason someone would want to consider debt settlement vs. bankruptcy — as well as debt management or debt consolidation. While there’s no such thing as a scot-free fresh start, there are less detrimental routes worth considering before defaulting to bankruptcy.

Here are two bankruptcy alternatives worth exploring:

Negotiating with creditors: You can often negotiate lesser settlements with your creditors, either on your own or by working through a debt relief program. This is an option for borrowers who are unsure how they’ll pay their debts in full and have fallen behind on payments, but want to avoid the finality of bankruptcy. If you skip any payments during this process, your credit score will sustain damage — but having late payments on your credit score tends to be less detrimental than bankruptcy. Settlement can help you zero out your debts for less than their original balances and allow you to start rebuilding your credit.

Work with a credit counseling agency: Credit counselors offer personalized advice based upon your financial situation, and can enroll you in a debt management plan (DMP) under which you consolidate your debts and pay them down through the agency in exchange for benefits like reduced interest/waived fees. DMPs tend to make it simpler and less expensive overall to work down debts over a period of three to five years but do require a commitment to making timely payments month in and month out.

Think of filing for bankruptcy as a last resort, rather than as a desirable option. This way, you’ll be able to do your research and make the most prudent choice for your situation — ideally without having to tarnish your credit report for a decade to come.

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