Is filing for bankruptcy bad?

Is it a good idea to file for bankruptcy? Many people hold strong opinions on the topic, and bankruptcy is often viewed as a social taboo. However, if nothing else can help, it can provide a much-welcome way forward, allowing you to move on with your life. 

Bankruptcy isn’t a simple solution, though, and there are many factors to consider first. It can help in more ways than many people realize, but it also doesn’t solve all debt problems that people commonly face. We’ll explain what it means to file for bankruptcy in this article, so you can get a better handle on whether it’s worth exploring further. 

What does it mean to file for bankruptcy?

Bankruptcy is a legal process that wipes away debt — under very specific circumstances — so that people who are seriously underwater can move on with their lives. 

Dedicated bankruptcy courts oversee the process under the guidance of a bankruptcy judge. A court-appointed trustee serves as the everyday liaison between the courts and the person filing for bankruptcy. Technically speaking, a bankruptcy attorney isn’t required, but given how complex the laws are and the high stakes involved, virtually all experts agree that they’re worth hiring to guide you through the process. 

In the U.S., individuals can generally file for one of two types of bankruptcy:

Chapter 7 bankruptcy: A quicker reset

A Chapter 7 bankruptcy is typically only available to people on a more fixed income and takes four to six months to complete, after which time your eligible debts will be erased. The court will appoint a trustee after you file, who will take stock of your financial situation and assets. Some of your assets will be exempt from bankruptcy, depending on the state you live in, and you’ll get to keep them. Your remaining assets, typically consisting of luxury or high-value items, will be sold or seized to repay your creditors. 

Unfortunately, many common debt types can’t be erased through bankruptcy unless very rare conditions are met, including:

• Alimony
• Child support
• Student loans
• Most tax debts

Bankruptcy also can’t provide as much help with secured debts, such as a mortgage or car loan. The court doesn’t have the power to extinguish any liens that your creditors might have, which gives them the right to foreclosure or repossession. Thus, while most people who file for Chapter 7 bankruptcy keep all of their assets, including their home, you’ll need to be current on your payments when you file and keep up with them throughout the process; otherwise, your lender could still take those things back.  

Chapter 13 bankruptcy: A lengthier solution for more complex cases

A Chapter 13 bankruptcy is available to those who don’t qualify for Chapter 7 bankruptcy, and — although a years-long process — offers certain advantages. 

You’ll get an automatic stay against any debt collection efforts, for example, which effectively halts things like a home foreclosure or wage garnishment from proceeding. (You get an automatic stay when you file for Chapter 7 bankruptcy, too, but given the quicker turnaround time, it doesn’t provide relief for as long as a Chapter 13 bankruptcy case.) 

Your assets aren’t at risk for seizure by the courts like in a Chapter 7 case. Instead, you’ll have to make monthly payments for either three or five years, depending on whether you earn less or more than your state's median income. The court will then distribute these payments to your creditors. When you’ve successfully followed through with your repayment plan, the court will discharge your remaining eligible debts, which generally include the same types as for a Chapter 7 case.

Is filing for bankruptcy bad?

Bankruptcy isn’t “bad,” in the same way that a home loan isn’t bad. They both offer legal routes for you to build your life and become a productive member of society in a way that otherwise might not be an option for you. 

Done thoughtfully, with guidance and consideration, it can be a positive experience despite the drawbacks. If you don’t do it responsibly, though, you could end up in a worse situation than you were before. 

The consequences of bankruptcy

Bankruptcy can provide a way to move forward through challenging times, but it shouldn’t be viewed as an “easy” button. It has numerous real and lasting consequences, which you should be aware of before committing to this path.  

Potential to lose assets

Chapter 7 and Chapter 13 bankruptcy both have different ways of treating your assets. You might be able to keep more than you might think — but you may also lose some things, too.  

In a Chapter 7 bankruptcy, you’re guaranteed the right to keep a certain level of assets, which generally varies by state. Washington state, for example, allows you to keep a median-priced home, a vehicle up to $15,000, and $10,000 in other belongings. You can “buy back” any assets above this amount, but if you can’t do that, any remaining assets can be seized by the courts and sold to repay your creditors. 

A bankruptcy court also can’t remove any liens on collateral that you use for a secured debt, such as a home loan or auto loan. Unless you’re able to continue making payments on those debts, your lender can still repossess or foreclose on them. 

Your assets aren’t taken away in a Chapter 13 bankruptcy case, but — as noted above — it’s still possible to lose things like your house or your car. One advantage of Chapter 13 bankruptcy, however, is that you can create a schedule to repay any past-due amounts on your secured debts as a part of your repayment plan, thereby allowing you to keep an asset that you otherwise might lose. 

Social stigma and stress

Bankruptcy isn’t viewed in a positive light in our society, unfortunately, and that can weigh heavily on many people’s decision on whether to go down this road or not. 

Court documents — including those filed in a bankruptcy case — are public records, available for anyone to view. Even if no one in your social circle knows that you filed for bankruptcy, for many people, just the knowledge alone that they filed for bankruptcy adds to their own personal stress and shame.  

High cost and complexity

You can represent yourself when filing for bankruptcy and even apply for filing fee waivers if you meet the requirements, making the process cost-free for you. However, most experts — and even the courts themselves — highly recommend hiring legal representation, due to the complex interplay of state and federal laws. In one study of Chapter 13 bankruptcy cases, only 2% of people representing themselves completed their plans, compared to 42% of those who filed with an attorney. 

Hiring a good bankruptcy attorney isn’t cheap, though, and can cost $3,000 or more. That’s a particular irony, considering bankruptcy helps people with limited financial resources. You can reach out to your local legal organizations to find resources like legal aid clinics and attorneys who offer payment plans to help with the cost.  

Long-term credit damage

One of the biggest long-term impacts of filing for bankruptcy is the damage to your credit score, although not everyone will be impacted equally. If you have a higher credit score to begin with, you’ll likely see a steeper decline than someone with a lower credit score who already has missed payments or defaulted loans listed on their credit report. 

According to Experian, a credit reporting agency, some people can expect a 200-point drop in their credit score. Another 2022 study showed that people with lower credit scores to begin with only saw an average drop of 55 and 29 points when filing for Chapter 7 and 13 bankruptcy, respectively. 

Your credit score doesn’t stay that low forever, though, and it will slowly start to rise again over time as you rebuild your credit. In the 2022 study, bankruptcy filers’ average credit scores were back on track in under a year.

However, your bankruptcy will still appear on your credit report for 10 years (for Chapter 7) or seven years (for Chapter 13). It may be challenging to obtain new credit during this period, including for things like a home loan if you need to refinance or relocate, or even a new rental if you are forced to leave your current home.

Potential impacts to co-signers and co-borrowers

If anyone else is listed on your debts, such as a co-borrower or a co-signer, it’s important to consider potential impacts on them if you file for Chapter 7 bankruptcy. 

Although you may be absolved of the debt, unless your co-debtor is also filing for bankruptcy, those protections don’t extend to them in a Chapter 7 bankruptcy case. They won’t benefit from the automatic stay granted by the courts, and lenders are free to pursue them for payment. If they weren’t planning on taking on that burden, it could cause them serious financial strain and potentially even force them into bankruptcy as well.

In Chapter 13 bankruptcy, however, your co-debtors are protected with the same automatic stay, even though they’re not filing for bankruptcy with you. However, if you don’t fully repay that debt during your repayment plan, your lender can pursue your co-debtors for any remaining balance after your debt discharge. 

Is bankruptcy right for me?

It’s often tough to know when you should file for bankruptcy or not. If you’re searching for ways to get out of debt, after all, chances are you’re already at a point where things are challenging. Luckily, you can look for some clues to help you decide. 

When bankruptcy might be a good idea

• You mostly need help with unsecured debts that are eligible for bankruptcy.
• You’re struggling to pay your bills and have exhausted other debt relief options.
• You don’t need to apply for new credit and your housing situation is stable for the near future. 
• Your debts don’t stem from poor financial management (or, if they do, you’ve taken steps to address them).
• You need immediate protection from a home foreclosure, wage garnishment, or other debt collection effort.

When bankruptcy might not be your best option

• You want to preserve your credit score, and/or need to apply for new credit in the near future.
• You can afford to pay back your debts within a reasonable amount of time, even if it’s not necessarily easy. 
• You haven’t taken any steps to address underlying spending habits, if that’s what led you into debt problems. 
• Your debts are largely ineligible for bankruptcy discharge, such as student loans, mortgages, alimony, child support, tax debts, etc. 
• Your co-signer or co-borrower can’t afford to repay the debt on their own (for Chapter 7 bankruptcy cases).

Bankruptcy vs. alternatives: when to consider other options

Bankruptcy isn’t the right tool for all situations, even if it seems like you’re struggling now. In order to know for sure, though, it’s good to rule out other bankruptcy alternatives first:

• Credit counseling: Nonprofit agencies offer a free session with a live counselor who can help you better understand your financial situation and options, including bankruptcy. If appropriate, you may be offered a low-cost debt management plan to help you get your debt under control without having to file for bankruptcy. 
• DIY debt payoff: Some people are able to create their own plan to pay off their debts faster using the debt snowball or debt avalanche method. Spending less money while you ramp up your income can help you achieve this goal faster than you thought possible. 
• Debt consolidation loan: If you have a consistent income and a good credit score, you may be able to use a debt consolidation loan to pay off any debt that carries a higher interest rate. Alternatively, if you have high equity in your home, you may be able to use financing tools like a home equity investment to wipe away your debt without monthly payments. 
• Debt settlement: You can try negotiating with your creditors to settle your debt for a lump-sum amount. Some companies will do this for you, but they charge a high price if they’re successful, which isn’t guaranteed. You could be sued for nonpayment, however, and if unsuccessful, you’ll owe additional fees and interest. 

Frequently asked questions

What do you lose when you file for bankruptcy?

You could lose some of your assets when you file for Chapter 7 bankruptcy, but state and federal exemption laws allow you to keep many, if not all, of your belongings. If you’re unable to keep up with any ongoing secured debts, like for your car or home, your lender can still take possession of those assets once your bankruptcy case is complete. 

Is life better after bankruptcy?

Often, yes, but not always. Bankruptcy provides a fresher start; your opportunities and abilities after you file for bankruptcy determine whether things will get better or not. 

Is filing for bankruptcy a good idea?

If you’re struggling to pay your bills, don’t have a clear path forward, and your debts are dischargeable in bankruptcy, then filing for bankruptcy can be a good idea. Most people are able to pay off their debts through effort and by using strategies like a home equity loan or home equity investment before it comes to that, though. 

Final thoughts

Filing for bankruptcy isn’t inherently good or bad. It’s a tool that you use, and under the right circumstances, it’s a very helpful tool — but it can also backfire if you don’t use it correctly. If you think bankruptcy might be your best option, it’s a good idea to get a second opinion from an expert, such as a credit counselor, financial advisor, or bankruptcy attorney. 

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