When Should You Consider Filing for Bankruptcy

Written By Jeff Hindenach
Last updated February 6, 2019

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Debt Relief
December 19, 2016

Simple. Thrifty. Living.

For anyone who’s overwhelmed by debt, bankruptcy can be a practical option. Still, it’s important to research one’s options before taking this important step.

Lots of people often seek out assistance from experienced financial professionals before making a decision about bankruptcy. Here are some common scenarios where bankruptcy is an option:

One way to evaluate the bankruptcy option is to look at debt versus assets. If the debt is significantly greater than the debtor’s assets and projected income, bankruptcy may be a good option.

For example, if a person has a monthly income of $1,000, and $10,000 in the bank, a $500 per month debt may be manageable. But if the debt is $2,000 or $3,000 per month, it’s easy to see how just a few months will eat up the capital reserve. In that case, as those months dwindle away, the person holding the debt can be going through the motions to start bankruptcy filing, just in time.

You can also look into debt consolidation and settlement, which can help lessen your debt and interest rates. Here’s a good list of the best debt consolidation and settlement services.

Those who have experience with bankruptcy situations may ask debtors questions like these:

  • Are creditors calling every day?
  • Do you feel constantly harassed?
  • Do you feel hopeless about your debt?
  • Is it hard to make other financial decisions because of your debt?

Typically, if there is a lot of credit activity and creditors have made it clear they’re not going to wait for payment, bankruptcy becomes a more attractive option, alongside debt relief. The emotional health of the borrower is also important, as coping with debt is a highly personal experience, and some people have a better tolerance for stress than others.

Another reason to file for bankruptcy is to protect other financial accounts, like an IRA. The government has ruled that Individual Retirement Accounts are generally protected in bankruptcy. By contrast, physical assets are generally not protected — in other words, people who have loans against their homes or vehicles will find that they are vulnerable to seizure in bankruptcy. This is an important consideration when contemplating bankruptcy.

Another time when bankruptcy filing can be a practical choice is when the debtor’s income is inconsistent.

For example, a person may owe a lump sum of money at a particular time. Income can be sporadic — for example, the borrower may not know if he or she is going to make anywhere from $2,000 to $6,000 in a given month. While the debtor may potentially earn enough money to pay down the debt, there is no guarantee that this is going to happen. In fact, the debtor’s situation could actually worsen. This reduces the chances that creditors might ever receive any payment.

In situations where a person has a variable income, Chapter 13 bankruptcy might be an option. Chapter 13 bankruptcy is a court-supervised repayment plan that lasts for three to five years. The debtor works with the court to prioritize debts and makes monthly payments to reduce his or her obligations. This form of bankruptcy allows individuals to manage their incomes and debts while protecting their assets.

About the Author

Jeff Hindenach

Jeff Hindenach is the co-founder of Simple. Thrifty. Living. He has a long history of financial journalism, with a background in newspapers such as the San Jose Mercury News and San Francisco Examiner, as well as being published in The Huffington Post, New York Times, Business Insider, CNBC, Newsday and The Street. He believes in giving readers the tools they need to get out of debt.

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