Consequences Of Filing Bankruptcy (2024)

The U.S. Bankruptcy Code gives people overwhelmed with debt the chance to regain their footing and start fresh. While bankruptcy can offer financial relief, the potential negative impact on your credit and overall finances shouldn’t be overlooked. Understanding the pros and cons of bankruptcy is key to deciding whether it’s right for you.

Here’s what you need to know about the consequences of filing for bankruptcy along with some alternatives to consider.

What Are the Consequences of Filing for Bankruptcy?

If you’re thinking about declaring bankruptcy, keep these consequences in mind.

Lowered Credit Score

Your credit score evaluates your ability to repay debt, so filing for bankruptcy will probably result in a blow to your credit. A bankruptcy remains on your credit report for up to 10 years and will continue to impact your score that entire time. That said, it’s possible to rebuild your credit after bankruptcy.

Decreased Access to Credit

Bankruptcy diminishes your ability to obtain new credit. If you can qualify for loans at all, they’ll likely have high interest rates and reduced credit limits. Mortgage qualification is particularly limited following a bankruptcy. Depending on the type of bankruptcy you file for, you may have to wait up to four years before applying for a home loan. This waiting period is shortened to two to three years for government-backed mortgage loans, and people who file for Chapter 13 (rather than Chapter 7) bankruptcy may only have to wait for one to two years.

Loss of Tax Refund

While you can receive tax refunds while in bankruptcy, your refund may be used to pay down federal tax debt. One of the Chapter 7 bankruptcy consequences is that your tax return may be turned over to your bankruptcy trustee to cover debts.

Potential Loss of Assets

Filing for bankruptcy can delay home foreclosure and car repossession, but eventually, some property loss is possible. In Chapter 7 bankruptcy, nonexempt assets are liquidated to compensate your creditors. And while Chapter 13 bankruptcy lets you keep your assets while making payments on an adjusted debt plan, if you default on your repayments, those assets may be at risk.

Some Debts Persist

Some debts can’t be discharged through bankruptcy. In general, debts incurred through the improper or illegal behavior of the debtor cannot be discharged. This includes:

• Debts not reported when filing for bankruptcy
• Child support and alimony payments
• Certain tax claims and unpaid federal income tax
• Debts for willful and malicious property or personal injury
• Amounts owed to specific tax-advantaged retirement plans
• Certain condominium or cooperative housing fees

Student loan debt is also notoriously difficult to discharge—although a recently introduced bill, the Student Borrower Bankruptcy Relief Act of 2022, could change that if passed.

Broader Impact

Bankruptcy is a matter of public record, so future employers or clients, family and neighbors can access this information. Additionally, anyone who shares responsibility for your debt will be impacted when you file. If you have a co-signer on any of your debts, creditors may still be able to pursue them for the balance, even if the debt is discharged in your bankruptcy. If you co-own a business, your partner may be required to buy you out to maintain the company.

Things To Do Before You File for Bankruptcy

Taking care of these tasks before filing for bankruptcy can help minimize the consequences mentioned above.

File Your Taxes

When filing for Chapter 13 bankruptcy, the IRS requires you to first file any required tax returns for all tax periods ending within the last four years. You must also file and pay applicable taxes during the bankruptcy process or apply for an extension. Your case may be dismissed if you fail to file your return or pay taxes during the bankruptcy process.

Avoid New Debt

Make sure you avoid incurring any new debt during the 70 to 90 days before you file. Intentionally accumulating debt you don’t intend to pay is considered fraud. Cash advances totaling over $750 or luxury goods exceeding $500 acquired within this timeframe will likely be considered nondischargeable debt.

Attend Credit Counseling

You must attend a credit counseling course administered by an approved credit counseling agency within 180 days before filing for bankruptcy. The credit counselor can explain bankruptcy consequences you may face and help you navigate your options.

Bankruptcy Alternatives

Bankruptcy is one of many options. Here are some alternatives.

Sell Your Assets

Your nonexempt assets may be liquidated during bankruptcy proceedings, so before filing bankruptcy, consider what could be sold. You’re likely to generate more money by selling the assets yourself instead of letting them go to a bankruptcy auction, and this extra money may be enough to improve your financial situation. Be sure to keep any documentation of the sales and charge a fair market rate, as selling assets far below their value may raise red flags if you need to file for bankruptcy.

Pursue Additional Income

If you have the capacity to increase your income, you may be able to avoid bankruptcy. Consider acquiring a part-time job and becoming a gig worker in your spare time. You can also try negotiating a raise from your current employer. Bringing in a few hundred dollars more each month could save you thousands of dollars on interest in the long run.

Debt Consolidation and Refinancing

If you have good credit and need to reduce your monthly debt payments, consider a debt consolidation loan. This option works well if you can qualify for a loan with a lower interest rate or lower monthly payments than your current debt.

While debt consolidation loans are typically unsecured loans, secured loans are sometimes touted as an option for people with poor credit. It’s generally wise to avoid getting a secured loan to cover your unsecured debt, as this puts your assets at risk. If you have high interest debt, such as a “Buy Here, Pay Here” car loan from a dealership, it may be advantageous to consider refinancing your debt at a lower rate through your bank.

Contact Your Creditors

Your creditors are invested in recouping as much of your balance owed as possible, so they may be willing to work with you to negotiate alternative terms or repayment plans. Contact the lender or debt collector and explain your circ*mstances. Provide a realistic estimate of what you can pay and when you can make those payments. Your creditors may be willing to cancel fees or reduce your interest rate or monthly payment.

You can negotiate your debt on your own, or you can work with a credit counselor, attorney or debt settlement company. Make sure to get any agreements in writing, and keep a detailed record of communication and payments.