Mary Reed and Gerri Detweiler are co-authors of "Debt Collection Answers: How to Use Debt Collection Laws to Protect Your Rights." They also answer debt questions at DebtCollectionAnswers.com
Bankruptcy is a painful choice and a complicated one. But if you’ve trimmed your spending to the bare bones and you’re still weighed down by too much debt, it may be time for the most drastic of our three debt diets.
The beauty of bankruptcy is that once you've filed, all attempts to collect your debts stop. That's why it's sometimes called "bankruptcy protection."
There are two types of bankruptcy: Chapter 7, liquidation, and Chapter 13, reorganization. A bankruptcy attorney can tell you which one may work for you.
Chapter 7, Liquidation: This option is typically best if you have a lot of unsecured debt (e.g. credit card and medical bills), and few assets.
Credit card and medical debt other kinds of unsecured debt are wiped out (discharged). But in return, the court may sell some of your assets—like your car—and give the money to creditors.
Remember that some types of debt—like student loans, unpaid income taxes, and child and spousal support—cannot be erased.
In Chapter 7, you get a choice about how to handle any secured debt you may owe, like your car loan and mortgage. You can:
- Formally agree to continue paying the debt.
- Buy the asset that secures the debt—i.e. pay off your car—assuming you and the lender can agree on its current value, and that you can pay for it with one lump sum.
- Return or surrender the asset to your lender so it can be sold and the cash applied toward what you owe.
Chapter 13, Reorganization: This option could be best if you have assets to protect (like your home), and have some money to pay off part or most of what you owe.
You keep your assets in exchange for paying all or some of your debts, depending on the type, under a plan the court must approve. Once you’ve completed the plan—usually in 3 to 5 years—any remaining dischargeable debt is wiped out and your bankruptcy is over.
Filing for bankruptcy can be a huge relief if you’ve got a ton of debt, but it will leave scars: Your bankruptcy will be in the public record for years to come, and your credit history will take a big hit for up to ten years.
However, you can begin rebuilding your credit once your bankruptcy is filed, and you embrace better money habits.
If you need help deciding whether this is the right step for you, read When is Bankruptcy the Right Choice?
Find a federally-approved credit counseling agency. You must complete a consultation with one no less than 180 days before you file bankruptcy. To find an agency, go to http://www.uscourts.gov/bankruptcycourts/approvedagencies.html.