When to File for Bankruptcy

When to File for Bankruptcy: The Main Reasons

Submitted by Sam Mazella - Sam Mazella is the Marketing Director of The Peterson Law Firm, the go-to practice in Arizona when facing divorce, child custody, child support and financial crisis. On his spare time, he enjoys cooking and doing camping trips with his family and friends.

(Contributions are guest opinions only and don’t reflect the opinion or endorsement of Money Fit by DRS, our staff, clients or other interested parties.)

Because of bankruptcy laws, individuals and businesses whose finances collapsed can have the opportunity to start over. The system relieves them from previous debts so that they can bounce back and reorganize their finances without being pressured by their creditors.

While the idea of a fresh start can be quite appealing, filing for bankruptcy comes with its own set of disadvantages and consequences. One has to think long and hard whether or not to sign their debts away for good and file for bankruptcy.

But when does filing for bankruptcy make sense anyway? And why do people do it? Read on to find out.

Why Declare Bankruptcy?

As mentioned, people declare bankruptcy to be relieved from their debts; to restart with a clean slate. However, there is often an underlying and more nagging reason why people choose to take this route despite the consequences. And that is to free themselves from the incessant phone calls, demand letters, and other pressuring collection attempts from the entities they have debts to settle with – legally, this is called the automatic stay.

Creditors are prohibited from contacting, pursuing, or filing a lawsuit against the indebted party after declaring bankruptcy. In individual cases, this also prevents circumstances like eviction and disconnection of utilities.

When Should You Consider Filing for Bankruptcy

While there is no perfect time to file for bankruptcy, there are scenarios where doing so makes sense – even beneficial.  If you're thinking about filing for bankruptcy, these questions should help you thoroughly assess your financial situation before taking the plunge.

Have you tried negotiating with your creditors?

One of the most obvious things to do before finally filing for bankruptcy is to sit and talk with your creditors just in case they agree to negotiate a repayment plan. If you've already done this but to no avail, or if they insist on getting paid in full, then you might not have any other option but to go ahead and file.

What does your liability-asset-ratio look like?

Another scenario where filing for bankruptcy could end up working in your favor is when your liabilities far exceed your assets, and it is becoming impossible for you to pay them. If servicing your debts alone cost more than your income, and you have little assets left, filing for bankruptcy might be a reasonable recourse.

Are you paying your debts with credit?

Paying debts with your credit card does not make sense as this only puts you into more debt. If your current situation has come to this, filing for bankruptcy can help you break the cycle. It may even erase your existing credit card debts.

How long will it take you to pay off your debts?

To get a better picture of your financial situation, total the amount of all your debts and calculate how long it’s going to take you to repay all of them. If it seems impossible for you to pay off a few of them within a five-year frame, then bankruptcy might be able to give you the relief you badly need.

What do you need to know before filing for bankruptcy?

Before filing for bankruptcy, you need to educate yourself on the types of bankruptcy and what they entail. The most common types of bankruptcy for individuals are Chapter 7 and Chapter 13.

A chapter 7 bankruptcy will liquidate your non-exempt assets to settle your debt with creditors. This is the best option for people whose incomes aren't enough to pay large, unsecured debts like medical bills or credit cards.

Chapter 13, on the other hand, will reorganize your debts with a repayment plan. Go for this if you have sufficient income, but you need more time to catch up on your debt payments or avoid foreclosure.

After you've filed for bankruptcy, it becomes a public record. Should you apply for a loan in the future, your potential lender will know. A chapter 7 bankruptcy will reflect on your credit report for the next ten years, while a chapter 13 stays for seven years. Also, expect your credit score to drop really low, around 50 – 200, which will make it almost impossible for you to get approved for loans.

Should you hire a bankruptcy attorney?

Bankruptcy can be a drawn-out and tormenting situation, and the process may take anywhere between six months to a year. Filing can become complicated, and you need to put in a lot of time and effort to get all the facts right. To make the process more manageable on your end, hire a seasoned bankruptcy lawyer.

While you can represent yourself - technically, attorneys are more adept and experienced in navigating the more complex areas of bankruptcy law. The fees may be steep, yes. But the possibility of getting discharged from your debts is also higher.