There were nearly 400,000 new personal bankruptcy cases, and over 13,000 new business bankruptcy cases, filed throughout the United States in 2022. Shocking as those figures may be, total filings were actually down 6.3% from 2021! Of course, the national numbers do not tell the full story. Some regions fared much better, whereas others fared much worse. For example, western states (California in particular) saw large decreases in bankruptcy filings, but parts of Louisiana and Mississippi experienced significant upticks.
Most folks understand bankruptcy to be a last resort, but deciding to enter the process is a difficult (and often emotional) decision.
Bankruptcy is an attractive option because it can “wipe the slate clean” by eliminating debts and stopping creditors from harassing you. On the other hand, a past bankruptcy filing can impact your credit history for up to ten years. Because of the far-reaching negative impacts, you should generally treat bankruptcy like the last resort it is—i.e., after all options have been exhausted.
What are the types of bankruptcies?
There are two main types of personal bankruptcies: Chapter 7 and Chapter 13. (Bankruptcy is a federal matter governed by Title 11 of the United States Code, which is further divided into chapters based on the type of bankruptcy.)
The most common personal bankruptcy is Chapter 7, which is known as a liquidation. Broadly speaking, in a Chapter 7 bankruptcy, the bankruptcy judge appoints a trustee to sell your assets and pay back creditors to the extent possible, after which your debts are discharged (i.e., canceled). You may be able to claim certain property as exempt from a bankruptcy liquidation, but any debt associated with exempt property will remain.
The other common personal bankruptcy is Chapter 13, known as a reorganization. Broadly speaking, in a Chapter 13 bankruptcy, you submit a plan to repay some or all of your debts over a three- to five-year period. The judge must approve your proposed plan. This option is appealing because it lets you keep your assets if you continue making the plan-approved payments for the length of the plan. Once you complete the plan, any remaining debts that were part of your bankruptcy case are discharged.
Individuals can also file for bankruptcy under other chapters in certain circumstances but those are relatively rare. Businesses typically file under Chapter 7 (most common), Chapter 11, or Chapter 13.
A few details to consider when filing for bankruptcy:
Debt cancellation is typically a taxable event because it is effectively the same as if you received income and then used that income to pay off the debt. There are exceptions to this general rule. Bankruptcy itself is not one of them, but most folks going through bankruptcy will meet one or more available exceptions.
Not all debt is “dischargeable” (i.e., can be wiped out) in bankruptcy. For example, student loans and tax debts are very difficult—albeit not impossible—to shed.
What should I do before heading to bankruptcy court?
Having an accurate picture of your overall financial situation—not only your net worth but also your monthly cash flow—is key. You cannot chart a path to get you from Point A to Point B without knowing your starting location, and you will never get out of debt if your monthly cash flow is negative. Once you have an honest assessment of your wants and needs, you can employ various strategies to pay down your debt and make sure you stay out of debt going forward.
While it may seem obvious, make sure the amounts owed are accurate in the first instance! Billing errors—whether due to incorrect medical coding, misapplication of insurance benefits, or an erroneous tax assessment—can quickly compound.
Download a copy of your credit report from each of the major credit reporting bureaus at annualcreditreport.com to make sure that you are accounting for all your debts.
Access your report from each bureau since accounts generally vary in their reporting.
Use this site because it is free as mandated by federal law. If you use another site, they may give you access to a credit report for “free” while requiring you to sign up for some sort of service.
Most lenders have options for you if you are struggling to pay your bills. They would rather receive a portion of the amount owed, or allow a delayed payment, versus seeing the debt discharged in bankruptcy court. Try working with your individual lenders first.
Mortgages and student loans are a perfect example. Ask for a forbearance (a temporary payment pause) or loan modification (changing the payment terms). Some of these are a matter of right, meaning it is granted automatically upon request, up to certain limits and can even be done online. It never hurts to ask.
Credit cards and utilities may also allow you to skip a payment, waive or reduce late fees, pay over a longer period of time, or negotiate the amount of your debt. (Do not pay for expensive debt negotiation services. You can do this yourself.)
There are even options if you owe back taxes. You can set up a payment plan, ask that your account be placed in hardship status (which temporarily stops collection activity), or submit an offer in compromise (where you agree to pay a portion of your debt). You must have filed all prior-year tax returns before seeking any of this relief. If back taxes is your main issue, I can help you get back on track!
Medical debt follows a similar approach. Simply call up the creditor (the hospital, dentist, etc. to which you owe money) and ask what options are available. The provider would prefer to work with you directly rather than sending your account to a collection agency or seeing you in bankruptcy court. For example, I remember paying off the cost of my wisdom teeth removal in my early twenties over an extended period of time; as long as I kept paying $50/month, I was never charged any interest.
There are various ways to save on medical costs that are beyond the scope of this article, which is what to do about existing debt.
Debt consolidation is another option. This involves taking out a new loan to pay off your existing debts. The main advantages here are simplification and cost. Rather than trying to work with ten creditors, for instance, now you can focus on just one. Cost savings may be realized, too, if the interest rate on your debt consolidation is below the rate on your existing debt (which is often the case with credit card debt). But be careful here, too. Many folks obtain a debt consolidation loan to pay off their credit cards, only to run up their credit card bills again shortly afterwards. Be sure that any debt consolidation will actually have its intended impact.
I tried all that. Now what?
You have taken a hard look at your finances to cut out all the unnecessary spending, worked with your lenders to obtain more favorable payment terms, and perhaps even tried debt consolidation, and still cannot see a way out. Your debt might literally be unmanageable. This is often the case for folks with large medical bills or unexpected job losses. It also happens a lot due to certain decisions by your younger self; many folks get to a point where they can meet their day-to-day obligations but simply cannot make any headway on past debt.
There is no shame in that. You are human. It happens. What counts is how you move forward.
Bankruptcy laws exist so you can get a fresh start and not be saddled with debt forever. Think of it as a financial rebirth (or a financial baptism, if you are spiritually minded). Just be sure you know what you are getting yourself into since there are financial repercussions. And because bankruptcy is a very complicated process in federal court, you should not try this on your own.
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