Overwhelming debt doesn’t just financially impact you, it can affect your mental health, your relationships, and your sense of control over your own future. But before it comes to that, there are steps you can take to avoid declaring bankruptcy.
What Is Bankruptcy and What Does It Mean for You?
Many people might not understand the difference between the two types of bankruptcy. Here’s a brief breakdown:
- Chapter 7 Bankruptcy: This type of bankruptcy wipes out most unsecured debt (credit cards, medical bills, and personal loans). In exchange, a court-appointed trustee may sell your non-exempt assets to repay creditors. It's a faster process than Chapter 13, but it comes at a cost, with a Chapter 7 filing staying on your credit report for 10 years.
- Chapter 13 Bankruptcy: Unlike when you file Chapter 7, Chapter 13 allows you to keep your assets but repay some or all of your debt through a repayment plan, allowing you to protect assets like your home. This type of bankruptcy stays on your credit report for seven years.
Regardless of type, declaring bankruptcy has serious and long-lasting consequences. Your credit score can drop by hundreds of points, and rebuilding it takes years. In the meantime, you may struggle to rent an apartment, qualify for a loan, or secure favorable interest rates. Depending on the type you file, you could also lose assets, while some debts, like student loans, child support, and tax debt, can't be discharged at all.
Steps to Take Before Considering Bankruptcy
Budget: Before you declare bankruptcy, make a list of every debt you owe, your interest rates, and overall expenses. It’s time to either create or modify your budget and find where you can cut back, like streaming services and other entertainment.
Contact Your Lenders: Don’t be afraid to reach out to your lenders and ask if they have any hardship programs.
Try a Debt Relief Strategy:
- The debt snowball is a method of repayment where you pay the minimum payments on the credit card with the smallest balance first until it’s paid off. Once that debt is gone, roll that payment into the next smallest. Rinse and repeat. This strategy gives you momentum that can help keep you motivated.
- While similar in function, the debt avalanche follows the same rules but instead of the credit card with the smallest balance, you work on paying the debt with the highest interest rate first until it’s paid off—helping you pay less interest over time.
Seek Professional Help: A credit counselor from a nonprofit credit counseling agency can sit down with you to build a budget tailored to your situation and help you evaluate the best path out of debt. That may include enrolling in a debt management plan (DMP), which allows your credit counselor to negotiate with your lenders for a lower interest rate and consolidate your debts into one affordable monthly payment. Through a DMP, you’ll typically pay off your debt in three to five years, saving you money and stress in the long run.