All You Need to Know About Bankruptcy Before You File

Written By:

Last Updated:Mar 15, 2024

All You Need to Know About Bankruptcy Before You File

Joy Wallet is advertiser-supported: we may earn compensation from the products and offers mentioned in this article. However, any expressed opinions are our own and aren't influenced by compensation. To read our full disclosure, click here.

If you have debt piling up and are struggling to make ends meet, it’s easy to feel overwhelmed or anxious. After all, money is a critical part of most people’s lives, since it allows them to provide food, shelter, and utilities for themselves as well as their family members.

Your ability to take out credit cards and loans that stretch your spending power beyond your actual means makes it easier than you’d think to create a precarious financial situation. The stakes get even higher when debt collectors start calling and threatening repossession.

If you feel like you’re between a rock and a hard place, you may be considering bankruptcy as you weigh other options like debt consolidation. Growing up playing the board game Monopoly, you probably have negative connotations of the word bankruptcy — associating it with losing all your money, and, in turn, the game. However, that depiction isn’t exactly accurate.

There are two major types of consumer bankruptcy, both of which could make sense in certain financial scenarios when you need a fresh start. Learn more about the pros and cons of filing for bankruptcy below.

In this article

Types of bankruptcy

Depending on your situation, you’ll likely be filing for Chapter 7 bankruptcy or Chapter 13 bankruptcy. While some corner cases have a different chapter (called this because of the corresponding section of bankruptcy code it refers to), most individuals find that they qualify for Chapter 7 or 13 bankruptcy more than any other type.

While both chapters offer debt relief, how they provide that relief does differ, particularly in considering your personal property, secured debts, and unsecured debts.

Get Debt Relief Today Even If You Have Bad Credit with TurboDebt

Relieve $25k+ in Credit Card Debt or Personal Loan Debt With TurboDebt

Relieve $25k+ in credit card debt or personal loan debt with this special relief program.
TurboDebt has a Trustpilot rating of 5/5 based on 1288 reviews
Subject to qualification and approval. $1,500 monthly income required.
Apply in 5 minutes. If you qualify, chat online with a friendly online debt representative.

Apply for Debt Relief Today With TurboDebt!

Chapter 7 bankruptcy

With a Chapter 7 bankruptcy case, you’re specifically looking at liquidating your assets and personal property to pay off your debts. During the liquidation process, you’ll have your unsecured debts paid off first, followed by secured debts. Your property will be managed by a bankruptcy trustee who will auction off different belongings and assets to ensure that your creditors are receiving the amount they’re owed.

For example, if your car gets sold for $20,000, that money would be distributed across all debt collectors to cover your debt responsibilities. Any non-exempt property or assets you have will be tapped to cover these debts during liquidation.

Generally speaking, you’ll be able to keep any assets that are essential to living, which should include your home; however, whether or not your property is exempt or non-exempt varies from state to state. So-called exemptions ensure that you aren’t left with just the shirt on your back when all of the dust settles.

Even so, it is possible to lose your home in a Chapter 7 bankruptcy. This is why some people choose to file a Chapter 13 bankruptcy instead because it can eliminate any proceedings and protect their home.

Before filing Chapter 7 bankruptcy, you’ll need to speak with a credit counselor. A credit counseling agency will offer you credit counseling services to help you rule out other options you may not have considered yet and get to the bottom of the poor financial decisions that have led you to this point.

Once you’ve received credit counseling, you can complete the necessary bankruptcy forms to begin the bankruptcy process—including your bankruptcy petition which lets local and federal courts know that you intend on taking your case to the bankruptcy court.

To avoid the abuse of Chapter 7 bankruptcy, you’ll need to be able to pass the means test first.

The means test is very simple to calculate: your monthly income - your monthly expenses from the 6 months before your bankruptcy paperwork being filed.

This gives you a number that constitutes your disposable income, or the extra money you could put to work paying down your debts but aren’t currently using in that way. Especially since Chapter 7 bankruptcy could potentially allow individuals to avoid foreclosure and still keep their home, the means test ensures that filing for bankruptcy isn’t ever used as a loophole for homeowners who are delinquent on their mortgage payments.

Chapter 13 bankruptcy

With Chapter 13 bankruptcy cases, you’re effectively agreeing to a repayment plan managed by a bankruptcy trustee at the direction of the court. Chapter 13 bankruptcy doesn’t require a means test, and rather than liquidating your assets to pay outstanding debts, reorganization of your finances helps to ensure your debts are repaid.

In this scenario, you and your bankruptcy lawyer will submit a payment plan to the bankruptcy courts and you’ll agree to pay a set amount of money to a trustee each month for 3 to 5 years that the trustee can use to pay down your debts.

One benefit of a Chapter 13 bankruptcy is that you may be able to reduce the interest rates on your existing debts since interest rates are lowered to the presumptive interest rate in a bankruptcy case.

You also can stop a foreclosure proceeding by filing for Chapter 13 bankruptcy, although a Chapter 13 bankruptcy provides much less of a fresh start than a Chapter 7 bankruptcy.

Pros and cons of filing bankruptcy

While there are certainly benefits of filing for bankruptcy, there are just as many drawbacks to consider, too. Determining whether or not you should file for bankruptcy isn’t a decision that should be taken lightly, so it’s a good idea to weigh the following pros and cons before you make your decision:

Pros

A major benefit of filing for chapter 7 or chapter 13 bankruptcy is receiving an automatic stay or bankruptcy discharge. An automatic stay or discharge can be one of the most immediate benefits when you file bankruptcy since it prevents lenders and debt collectors from contacting you to try and collect on debts you may owe them. This can be a huge relief if you’ve been dealing with stress and harassment from debt collectors.
If you’ve just lost a major portion of your income or have significantly fallen behind on your mortgage, filing for bankruptcy may also be advisable since it could help you avoid foreclosure.

Cons

Losing a portion of your property or investment assets to a bankruptcy proceeding can hurt your future financial prospects.
A bankruptcy can also negatively impact your credit score for many years, staying on your credit report for anywhere from 7 to 10 years. Since you need to meet certain income requirements to be eligible to file for bankruptcy, it’s also worth remembering that bankruptcy isn’t a one-size-fits-all solution for everyone struggling to stay on top of their debts.

Talk to an attorney

Due to the complexity of the bankruptcy code and the huge impact it can have on your life, it’s inadvisable to try filing for bankruptcy without a lawyer.

A bankruptcy attorney will know the ins and outs of the process, offering you legal advice about whether it’s financially advisable to file for bankruptcy in the first place, from managing the meeting of creditors where your debts are checked for accuracy against your trustee’s paperwork.

Since bankruptcy is such a monumental decision to make, it’s definitely worth the attorney fees and filing fees to work with an experienced professional during your bankruptcy case.

Get Debt Relief Today Even If You Have Bad Credit with TurboDebt

Relieve $25k+ in Credit Card Debt or Personal Loan Debt With TurboDebt

Relieve $25k+ in credit card debt or personal loan debt with this special relief program.
TurboDebt has a Trustpilot rating of 5/5 based on 1288 reviews
Subject to qualification and approval. $1,500 monthly income required.
Apply in 5 minutes. If you qualify, chat online with a friendly online debt representative.

Apply for Debt Relief Today With TurboDebt!

The bottom line

Filing for bankruptcy is a serious and drastic financial step, and attention should be paid to this weightiness. Make sure that you’ve thoroughly exhausted your other options before considering bankruptcy.

If you still feel like bankruptcy is something worth pursuing based on your financial situation, reach out to an attorney and discuss your situation with them. Having some knowledge of Chapter 7 and Chapter 13 bankruptcy ahead of time will ultimately make these conversations with your lawyer more productive and ensure you’re on the right path.

With the right information and a team of trusted professionals on your side, you’ll be able to make the correct decision for your unique financial situation and get the relief you need.

Joy Wallet is an independent publisher and comparison service, not an investment advisor, financial advisor, loan broker, insurance producer, or insurance broker. Its articles, interactive tools and other content are provided to you for free, as self-help tools and for informational purposes only. They are not intended to provide investment advice. Joy Wallet does not and cannot guarantee the accuracy or applicability of any information in regard to your individual circumstances. We encourage you to seek personalized advice from qualified professionals regarding specific investment issues. Featured estimates are based on past market performance, and past performance is not a guarantee of future performance.

Our site doesn’t feature every company or financial product available on the market. We are compensated by our partners, which may influence which products we review and write about (and where those products appear on our site), but it in no way affects our recommendations or advice. Our editorials are grounded on independent research. Our partners cannot pay us to guarantee favorable reviews of their products or services.

We value your privacy. We work with trusted partners to provide relevant advertising based on information about your use of Joy Wallet’s and third-party websites and applications. This includes, but is not limited to, sharing information about your web browsing activities with Meta (Facebook) and Google. All of the web browsing information that is shared is anonymized. To learn more, click on our Privacy Policy link.

Images appearing across JoyWallet are courtesy of shutterstock.com.

Brent Ervin-Eickhoff is a Chicago-based writer, stage director, and filmmaker with a background in digital marketing and content creation. In addition to Joy Wallet, Brent has written for Complex, Volkswagen, HowlRound, Picture this Post, and Third Coast Review, among others. He currently serves as the Associate Director of Marketing for Content Creation at Court Theatre at the University of Chicago. Brent graduated from Ball State University with Academic Honors in Writing.

Share this article