5 terrible reasons to file for bankruptcy
By Miranda Marquit
December 24, 2014
When you feel as though your financial situation has become untenable, bankruptcy can seem an attractive option. And, if you are considering bankruptcy, you aren't alone.
During the 12-month period ending Sept. 20, 2014, there were almost 1 million bankruptcy filings in the United States.
After coming through one of the worst economic situations in living memory, bankruptcy has lost much of its stigma. Indeed, since the 1960s, the stigma associated with personal bankruptcy has weakened, according to research from California State University, Northridge and Stanford. Recent events have only served to provide increased sympathy for those who feel they have no more options. As more and more people see friends or family members forced to seek refuge from creditors, the shock of bankruptcy is wearing off.
Just because you can file for bankruptcy, and do so without losing social status, doesn't mean that you should, though. First of all, it's not as easy as you think. Bankruptcy legislation passed in 2005 requires counseling, and places a number of restrictions on filing. Before you file, you want to make sure that you aren't doing so for any of the following five terrible reasons:
1. You expect a “mulligan”
The myth of the financial “do-over” has long been attached to bankruptcy. However, if you expect a clean financial slate after bankruptcy, you are in for an unpleasant surprise. Bankruptcy doesn't wipe out your past transgressions. Instead, a bankruptcy signals that you have been unable to responsibly deal with credit in the past, and it sends up a red flag. For the next few years, you might find it difficult to qualify for a loan, and you might have to pay higher rates for certain services, such as insurance. It can also affect employment and the ability to rent.
Additionally, many filers are required to use Chapter 13 bankruptcy, which results in repaying the bulk of your creditors, rather than the more popular Chapter 7, which allows you to get out from under most debts, while stripping you of your assets. With Chapter 13, rather than watching the debt disappear, you create a three- to five-year payment plan.
2. You hope to get away from student loan debt
With the high cost of college contributing to more than $1 trillion in outstanding student loans, it's no surprise that many grads wish they could get out from under that debt. Bankruptcy, however, is not the option. In fact, it's not the option if you want to overcome other types of debt as well, including domestic support and back taxes, says bankruptcy law expert Michael Greiner. Those debts are not erased, or “discharged,” by bankruptcy.
3. You hope to protect your assets
One way that some consumers try to protect their assets, whether it's from garnishment or from a lawsuit, is to file for bankruptcy. Unfortunately, bankruptcy doesn't always protect your assets from these actions, especially if the timing involved suggests that you are only filing for bankruptcy in an attempt to avoid paying what the law requires. An attempt to file for bankruptcy to avoid a lawsuit judgment, or reduce child support payments is considered abuse. There are penalties for giving false information and for abuse. If the court researches your situation, and finds your bankruptcy abusive, it could reject your petition.
“Your poor credit does not directly impact your spouse.”
–Michael Greiner, bankruptcy law expert
Not only is this type of scheme often useless, it is rarely necessary. “You want to protect your retirement income, savings or Social Security from garnishment,” says Greiner, “but those kinds of income and savings are typically not subject to garnishment anyway.”
Before you file for bankruptcy to protect your assets, research the law in your state, consult with a knowledgeable attorney to assess your options and look for other asset protection strategies.
4. You want to protect others from your debt
For some consumers, bankruptcy is a noble effort to protect others from the effects of debt. Perhaps you worry that your heirs will be stuck with the fallout from your debt, or you don't want your future spouse sharing in your financial predicament.
These worries are usually unfounded. “Debts are not inherited,” says Greiner. So, even if you die and your estate can't handle your obligations, your heirs won't be required to make good. The exception is if your heirs have agreed to co-sign on the debt, or if you have joint credit accounts.
Similarly, if you're contemplating marriage, bankruptcy isn't the way to shield your future spouse from your financial obligations. “Some people consider bankruptcy prior to marriage in order to protect a future spouse from the credit predicament,” Greiner says. “But your poor credit does not directly impact your spouse.”
Unless your spouse signs on to your debt, most states will keep your credit separate. In fact, you can make things worse. If you file for bankruptcy, and then the two of you try to get a mortgage together, the application could be rejected due to your filing.
The best way to protect others from your debt is to make sure it remains yours. Don't ask your loved ones to co-sign loans for you, or to be listed on joint debt accounts until you get your finances in order.
5. You want to move beyond identity theft
“I can't tell you how many people file and ruin their credit rating out of desperation after being victimized by identity theft, cybercrime or fraud,” says Alexis Moore, a cybercrime expert and advocate.
Because it can take time to sort out some of the issues related to identity fraud, it's possible for charges to remain on credit cards or fraudulent loans to stay on credit reports for longer than expected. In some cases, victims are called by agencies looking to collect on debts that aren't actually theirs. “Once the bills start piling up and the threats of litigation come in, many consumers just decide they want to file for bankruptcy,” Moore says. “This topic is hardly addressed, but it is real and happening all the time.”
Instead of filing for bankruptcy protection, Moore suggests working with credit reporting agencies to have the fraudulent accounts removed. Reporting the situation to law enforcement can bolster your case and speed the process. Additionally, you can freeze your credit so that future scammers have a harder time accessing your credit.
Before pursuing bankruptcy, look at other options. There is debt counseling, in which a nonprofit debt counseling agency negotiates on your behalf to reduce interest and fees. You pay down debts with a single monthly payment. However, that is not the solution for some for a variety of reasons, including insufficient funds.
Another possibility is doubling down on your payments, and getting creative with your cost-cutting measures. You can also sell items you no longer need. Finally, know that paying off the debt isn't all you need to focus on — you need to learn how to stay out of debt as well.
Filing for bankruptcy might seem like your only way out in many situations, and it might be. However, before you take that step, make sure that it truly is your last option — and that it will actually help you rather than further hurt your finances.