When Bankruptcy is the Right Choice

RainBankruptcy still has that whiff of shame and failure, but in some cases it's the best possible move under the circumstances.

The question is: Which circumstances signal that declaring bankruptcy could be the smartest move for you? Personal bankruptcy filings in October reached a new high, according to the American Bankruptcy Institute, with a 28% increase compared to October 2008.

People often wait too long to file, putting themselves at greater risk than necessary, says Elizabeth Warren, Harvard Law professor and leading bankruptcy researcher (and lately the outspoken head of TARP, the Troubled Asset Relief Program). Bankruptcy is a safety net, designed to clear some or all of your debts while preserving some assets and savings so you can move forward. Ideally, say experts, it's better to file sooner, before you deplete the resources that could help you get back on solid ground.

You may want to consider bankruptcy if:

  • …it would take you five or more years to pay off your debts.
  • …if you're about to take out a home equity loan to get out of debt (and it's not the first time).
  • …if you're about to cash out your retirement fund as a bailout.
  • …if you've cut back every possible expense and you still can't keep up with even the minimum payments on what you owe.

Bankruptcy laws vary by state, as my MSN Money colleague Liz Pulliam Weston writes:
Filing Chapter 7, the most common form of bankruptcy, will erase most consumer debt (credit cards, medical bills), but not student loans or taxes. You may give up some property or home equity as repayment.

Filing Chapter 13 is considered a "reorganization" of your debts. You keep most assets but agree to repay some of your debt over three to five years.

Will bankruptcy ruin your credit rating? For a while, yes, although many people who enter bankruptcy have already wrecked their credit, and filing actually gives them a shot at rebuilding their lives more quickly.

The key thing to remember, DW devotees, is that bankruptcy is just a temporary solution to a much bigger problem (see what I wrote about it in the New York Times last January). Ultimately it's up to you to apply the great advice you get here and elsewhere, to understand how and why you spend and what you really want from your financial life.

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