Stated by The Phenix Group, one of the main reasons that people are reluctant to file for bankruptcy even when they are drowning in debt is that bankruptcy negatively impacts one’s credit score. Depending on the type of bankruptcy on file, the filer can expect a total score drop of 160 to 220 points.
Even if you had good credit to start with, this is a significant drop and one that will probably discourage all creditors from issuing loans or giving out credit cards.
Still, the reason that many people ultimately do file is that they simply have no way out of their situations and they come to realize that letting debts age and pile up is ultimately harsher on your credit score than waving the white flag and admitting that they have no solvency.
Why Bankruptcy May Be Better Than Waiting It Out
Hopefully, you are not on the brink of bankruptcy, but you may be wondering what benefit there would be to filing bankruptcy as opposed to just letting your debts go unchecked. First of all, it is essential to know precisely what filing for bankruptcy does. Depending on the kind of bankruptcy you are filing, doing so effectively lets you off the hook legally for any outstanding debt that you have.
This means that creditors no longer have the option of taking you to court to collect on delinquent debts. That may sound enticing but keep in mind that bankruptcy can murder your credit score.
So is bankruptcy better than just waiting it out? That depends. Most states impose a statute of limitations on debt, which means that a creditor only has a certain amount of time to sue a person for failing to pay a debt.
In some states, the statute of limitations expires after 4 years so whether or not it would be better to roll the dice and pray that you can be delinquent long enough without your creditor suing will depend on the state you live in.
It will also depend on your age, marital status, and income. A creditor will be less inclined to act before the statute of limitations expires and actually sue you if you are a senior citizen living on a fixed income. But let’s say you are in your 30’s, have a job and don’t have a spouse and have not started a family. Then you are a juicy target for litigation because not only will you have the time to pay off your debt as mandated by a judge, but you have a job and source of reliable income.
In this case, it would probably be preferable to file for bankruptcy than taking a huge risk that a creditor won’t sue you while they have the opportunity.
Differing Kinds of Bankruptcy
By far, the two most common types of bankruptcies filed in the US are chapter 7 and chapter 13. To put it in simple terms the main difference between these two is that chapter 7 is a relinquishing of all debts legally and chapter 13 is more like a legal payment plan that is decided in the courts.
7 will automatically relieve you of debt and 13 will adjust the way that you must pay your debt. But, as always, there are caveats.
A Breakdown of Chapter 7 Bankruptcy
To be eligible to file for chapter 7 bankruptcy, you must prove beyond the shadow of a doubt that you do not have the income to pay off your debts feasibly. Chapter 7 gets you off the hook legally for having to pay back your debts, but it can be excruciating and not just because it lowers your credit scores. The court will decide which of your assets are nonexempt, and any nonexempt assets or properties will be appropriated and sold to help pay off your debts.
You can keep any property or asset that the court deems exempt.
So it is conceivable that a court will deem a debtors home as nonexempt property if for example there is high equity on the home. In this case, the debtor’s home will be taken and sold. Any remaining debt that cannot be paid off by liquidating nonexempt assets will be transferred from the filer of chapter 7 and committed to a court-appointed trustee.
A Breakdown of Chapter 13 Bankruptcy
Chapter 13 bankruptcy allows the debtor to settle on a payment plan with their creditors. Unlike chapter 7, chapter 13 does not get the debtor off the hook for paying back debts. Instead, it allows the debtor to work out a payment plan over 3 or 5 years, depending on the situation. The payments then go to a trustee who doles it out to creditors, and the debtor has no more direct contact with entities they owe money to.
Chapter 13 will also halt foreclosure proceedings, which allows the debtor to keep their home and nonexempt assets.
How Long Do Chapter 7 and Chapter 13 Stay on Your Credit Report?
Another critical distinction between chapter 7 and chapter 13 is how long they affect your credit score. The law stipulates that any bankruptcy will not stay on the debtor’s record for more than ten years. In the case of chapter 13, however, the motion will only be on your credit report for 7 years.
Chapter 7’s usually stay on your record for 10 years since the situation is often direr and the individual is basically saying they have no way of paying back the debts.
You don’t have to do anything to get these marks off your record as they are required by law to be dropped off after 7 or ten years. There are also ways that you can start to rebuild your credit in the 7 or 10-year span that the filing stays on your record. While bankruptcy is a very serious situation and can ravage your credit, all hope is not lost. With time and responsibility, you can come out of it better and more successful in your credit repair journey.