How to Know When to File for Bankruptcy

Bankruptcy is a big deal. Completing bankruptcy can discharge — or wipe out — debts you can't afford to pay. It can also cripple your finances and tank your credit score for years. When deciding whether to file, you have several things to consider.

Will It Help?

Filing bankruptcy discharges most debts, the U.S. Courts website says, but not all of them. Among the debts that will survive Chapter 7 bankruptcy are:

  • Back alimony or child support
  • Government fines and penalties
  • Some tax debts
  • Student loan debt
  • Debts caused by an incident that involved driving under the influence
  • Debts stemming from willful and malicious injury to someone else

Chapter 13 can discharge a broader range of debts, but it won't erase all of them either. If your problem debts fall into a protected category, filing bankruptcy may not give you the relief you seek.

What Will You Lose?

In Chapter 7 bankruptcy, a court trustee sells off your nonexempt assets to pay your creditors before your remaining debts are discharged. In Chapter 13, you spend three to five years paying back your creditors before the discharge. Financial and legal requirements may limit your ability to choose which chapter you prefer.

If you own a home, the trustee can sell it in Chapter 7, unless your state's bankruptcy exemptions — which you can find at the Nolo website — protect your equity, the value in your home above the mortgage debt. If you have more equity than your state exempts, filing Chapter 7 could cost you your home.

If you're behind on the mortgage and want to keep the house, Chapter 13 may be a better option. The trustee doesn't sell your assets, and you can catch up on back payments as part of the payment plan. However if you simply can't afford to keep up the monthly payments, neither chapter will prevent the lender from foreclosing. If the mortgage is your primary concern, asking the lender about mortgage modification first could be a good move.

What's Your Income?

If your income for the six months before you file is above the state median, you may not qualify for Chapter 7 bankruptcy. The Nolo legal website suggests that if you've suffered a recent drop in income — you've lost your job or taken a pay cut, for instance — you should wait a few months so that your average income is lower.

If you're expecting a sizable tax refund and it arrives after you file, the money may go to your creditors. If you wait until after you've received and spent it to file, that's not an issue.

What's the Alternative?

If you don't have many assets creditors can seize or your income is immune from garnishing, your creditors may not be able to collect from you. For example, if you only earn $217 a week at the time of publication, your wages can't be garnished. You may not need the protection that bankruptcy offers.

If you're simply fed up with debt collectors calling you, federal law gives you the right to order them to stop. This doesn't apply to the original creditor -- only third-party collection agencies. It may still bring you relief, though.

Who Else Gets Hurt?

If you co-signed a loan or bought a house with someone else, your creditors may be able to sue your co-signer for the loan. This isn't something to take lightly.