It seems like you’re drowning in debt. Until now, if you’ve been a little
short, you’ve just borrowed money to pay that last bill. Now you are nearing or
exceeding your credit limits, and you can’t get the money to satisfy all of your
creditors. Maybe you’ve received polite calls about when you intend to pay, or
maybe one or two have threatened to refer their debt to collections, file lawsuits,
repossess collateral, or foreclose. If you pay the most aggressive creditor, you
might not have enough money left to pay the other ones that you can handle, or even
have enough to pay for the roof over your head, for your ride to work, the insurance,
the utilities, or even the grocery bills. Is this your situation?
Everyone needs credit to buy and keep cars and houses, and people also rely
on credit to get out of debt trouble. Credit cards, loans, and family members can be
a source of credit. Nobody wants to hurt their credit. People with good credit say
that filing bankruptcy will destroy your credit, which is a reason why most people
don’t consider bankruptcy until after they’ve tried everything else first. The truth is
that in some situations, filing bankruptcy is a cost-effective option that opens doors
that are closing, and it can be a life saver.
To understand the effect of bankruptcy on credit, you need to know how
credit scores are calculated. At the margins, the three credit reporting agencies
consider many complicated factors to fine tune their scoring. However, as a
practical matter, there are two factors that influence your credit score more than all
the others combined: 1) your credit history, that is, whether you are paying your
debt on time, and 2) your credit utilization ratio, that is, how much of your
available credit is left. Slow payments and maxing out credit hurts the score.
For one reason or another, at some point paying your bills on time may not
be an option that is available to you. You can be caught in a downward spiral. If
bills become delinquent, that alone hurts your credit, and delinquencies can lead to
garnishments, repossessions, and foreclosures which hurt your credit severely if the
debt collection process goes that far. If your credit is not good enough to allow you
to borrow your way out of trouble, then maybe it is time to consider the benefits of
filing for bankruptcy.
There are two types of consumer bankruptcy, Chapter 7 and Chapter 13.
When you file either one, the protection of the Bankruptcy Court is instantaneous,
so that state collection actions are automatically suspended until the legal process
has time to work itself through. Since state collection actions like lawsuits damage
credit scores, avoiding those actions helps credit.
Chapter 7 will wipe out general unsecured debt. If you can afford to keep
paying for secured debt, like houses and cars, you can usually keep those things in
Chapter 7. As for credit, wiping out debt in Chapter 7 actually improves your “debt
utilization ratios”, because after some of your debt is wiped out (“discharged”), a
greater percentage of your income will be available to pay the debt that remains.
Almost all people who file for Chapter 7 will receive a discharge within three or
four months, with very little going on in the meantime.
Chapter 13 is a court-protected reorganization plan that can take up to five
years to complete. In Chapter 13 you can force secured creditors like mortgage
lenders or auto lenders to allow you to cure defaults over time whether the creditor
wants to work with you or not. It is also possible in some plans to pay little or
nothing on unsecured debt, which can make Chapter 13 plan payments much more
After filing Chapter 13, a Debtor may not incur additional consumer credit
without first seeking court permission. Although approval is not automatic,
reasonable proposals to refinance or buy houses or cars can be, and usually are,
accomplished by filing a motion with the court. The first step is to talk to the
bankruptcy lawyer for advice about finding an appropriate lender.
Filing Chapter 7 is not a legal impairment to using credit. Whether a lender is
willing to lend is a separate question, and it varies by lender. After bankruptcy,
credit applications just keep coming anyway, and the best decision may be to turn
them down. You may buy cars before your discharge, and some lenders are
specifically set up to lend to bankruptcy debtors. To get a government backed
mortgage, you need to wait about two years after a discharge. However, there are
no time limits imposed by law, and conventional lenders may not require any such
time restriction. In any event, according to a 2019 study by the U.S. government’s
Consumer Financial Protection Bureau, median credit scores increase steadily from
year to year after filing a bankruptcy petition.
Filing bankruptcy is not a financial alternative that people choose if they have
better options. However, financial recovery without it may be next to impossible,
and financial recovery with it is certainly possible. Every case is different. Call us
at 770-683-3303 to discuss your unique situation.