When Bankruptcy Is the Best Option

Bankruptcy may make sense depending on how much debt you have, your other financial obligations and if you’ve tried other debt relief methods.

Tiffany Curtis
Liz Weston, CFP®
By Liz Weston, CFP® and  Tiffany Curtis 
Updated
Edited by Courtney Neidel

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If you file for bankruptcy, it doesn't make you a failure, and it may even help give your finances a fresh start.

Bankruptcy stops collection calls, lawsuits and wage garnishments. It erases some forms of debt; and despite what you’ve heard, bankruptcy may help your credit scores.

Credit bureaus and scoring experts often say bankruptcy is the single worst thing you can do to your scores. Foreclosures, repossessions, charge-offs, collections — nothing else can drive your scores down as fast and far as a bankruptcy.

But that’s not the whole story. Many people struggle so long with their debt that their credit has already been hurt by the time they file for bankruptcy. And once they do, their scores typically rise, not fall. If the debt is erased — which is known in bankruptcy court as a “discharge” — scores go up even more.

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Potential benefits of filing for bankruptcy

One of the biggest advantages of filing for bankruptcy, is the possibility of a fresh financial start. Bankruptcy isn’t a quick fix, but having your unsecured debts cleared (like in Chapter 7 bankruptcy), may give you a clean slate that allows you to improve your financial habits and circumstances. Some of the other potential benefits of filing for bankruptcy include:

An end to persistent debt collection: People who file for bankruptcy benefit from its “automatic stay,” which halts almost all collection efforts, including lawsuits and wage garnishment. If the underlying debt is erased, the lawsuits and garnishment end.

Freedom from certain debts: Chapter 7 bankruptcy wipes out many kinds of debt, including:

  • Credit card debt.

  • Medical bills.

  • Personal loans.

  • Civil judgments (except for fraud).

  • Past-due rent.

  • Past-due utility bills.

  • Business debts.

  • Some older tax debts.

Some debts, including child support and recent tax debt, can’t be erased in bankruptcy. Student loan debt can be, but it’s rare. But if your most troublesome debt can’t be discharged, erasing other debts could give you the room to repay what remains.

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Don't wait too long to consider bankruptcy

Sometimes we feel we have a moral obligation to pay what we owe — if we can.

If you can pay your bills, you should. If you’re struggling, check out your options for debt relief. But bankruptcy may be the best option if your consumer debt — the kinds listed above that can be erased — equals more than half your income, or if it would take you five or more years to pay off that debt.

Here’s what you need to know:

You need a bankruptcy attorney: It’s easy to make a mistake in the complicated paperwork, and an error could cause your case to be dismissed. If that happens, you end up with no relief — but still have credit scores lowered by the bankruptcy filing.

Attorneys typically want to be paid upfront: There are some legal aid and pro bono services available, but they’re often overwhelmed by demand. If you’re really strapped, call the bankruptcy court in your area to find out what resources are available. Your local bar association may be able to direct you to attorneys willing to take on some pro bono cases. Otherwise, you’ll need to scrape up some cash to cover .

Don’t wait too long: There’s a misconception that people file bankruptcy at the drop of a hat or when they still have other options. The reality for most is quite different. Some drain assets, such as their retirement accounts, that could have been protected from creditors in bankruptcy. That’s why we advise debtors in over their heads to investigate bankruptcy first.