Clean Slate? What You Need to Know Before Filing for Bankruptcy

Business.com / Accounting / Last Modified: February 22, 2017

Filing for bankruptcy might sound like a clean slate, but there are some strings attached. Here's what you need to know before filing.

The experts may claim that the recession is over, but many people and businesses are still struggling.

In fact, the latest statistics from the U.S. Courts reveal that though bankruptcies are decreasing nationally, the number of both individuals and businesses choosing to file for bankruptcy is still substantial.

If you are considering bankruptcy, here are a few things you should consider before you become a bankruptcy statistic.

Not All Debt is Dischargeable

It is a common misconception that going through bankruptcy gets rid of all of your debt. However, not all debt is dischargeable (forgiven) in bankruptcy. For example, alimony and back child support are never dischargeable. In a business context, unpaid taxes remain a big debt that still has to be dealt with after other debts are paid off or wiped out.

Other types of debt are only dischargeable under certain circumstances, varying according to the type of bankruptcy filed. A good example of this is student loan debt.

It used to be that student loan debt was never dischargeable, but this has begun to change as courts realize that an increasing number of students are graduating from college with a debt load impossible for them to handle.  Graduates proving severe financial hardship may have a new option available to them in the form of a three-part test for undue hardship, The Brunner Test, that assesses the debtor for poverty, persistence, and good faith. 

Related Article: How to Prevent Bankruptcy in a New Venture

Filing for Bankruptcy is Not Free

Another common misconception is that filing for bankruptcy is free. It is not. The court charges a filing fee, and if you hire an attorney you will have to pay him or her as well.  If you are in dire straits, however, these costs can often be put on a payment plan.

If the cost of hiring an attorney is the only thing holding you back from filing for bankruptcy, you should know that it is possible to go through bankruptcy without the assistance of an attorney. Filing on your own, however, also known as filing pro se, is not recommended since the process is quite complex, and you can be barred from filing again if you mess up the first time.

The bankruptcy court has a great deal of information on its website designed to help you figure out how to proceed if you want to go it alone, but you should also consider getting a cost estimate from an attorney since you might be surprised at how affordable having an attorney guide you through the process can be. Most bankruptcy attorneys provide a free initial consultation during which you can discuss pricing.

Bankruptcy is Not One Size Fits All

A third common misconception about bankruptcy is that bankruptcy is a one size fits all operation. In reality, there are several different kinds of bankruptcy. Which type is appropriate for you depends on the type of debt you have and what your post-bankruptcy goals are. The most common types of bankruptcy, each named after the chapter of the law that created it, are Chapter 7 and Chapter 13 for individuals and Chapter 11 for businesses.

By using exemptions, which allow debtors to maintain possession of certain property during and after the bankruptcy, each of these types of bankruptcy can be further customized.

For example, a family filing Chapter 7 bankruptcy may choose to keep their current home, one of their cars, and the diamond ring inherited when grandma passed away. This helps ensure that at the end of the bankruptcy process the debtor is in a much better place financially and emotionally than he or she would be if he or she was forced to sell literally all of his or her possessions.

Potential filers should also look into what other options are available to them since there is a growing flexibility in the financial system due to the sheer number of people facing financial difficulties. Renegotiation, consolidation, and payment plans are increasingly available in circumstances where only a few years ago they would not have been an option.

A Clean Slate, But With Strings Attached

Although a useful tool for many, bankruptcy can, for some people, become a burden, dragging them down for years to come.

Many people do not realize that filing for bankruptcy significantly impacts the filer’s credit score. It may be difficult to obtain a loan or even a credit card for a few years after filing bankruptcy. A low credit score can also limit a filer’s employment options since some businesses require their employees to have certain credit score and a clean financial background.

In addition, filing prematurely can prevent you from filing when it becomes absolutely necessary. Debtors can only file for Chapter 7 bankruptcy once every eight years. While debtors can file for Chapter 13 bankruptcy more frequently, the ability to discharge debts is often reduced each time a debtor files.

Think Before You File

Filing bankruptcy is not something that should be done lightly. It is a serious decision that has significant consequences. Nobody should file without first becoming informed about all that the process entails and about what its long-term impact will be.

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