The Deadly Lifesaver: Things to Know (or Avoid) When Declaring Bankruptcy

When you made your first couple of dimes at your lemonade stand as a kid, the idea of bankruptcy never crossed your mind. Back then, making money seemed to be as easy as mixing sugar and water, but, unfortunately, our finances could sometimes get away from us and turn into more of a burden than a blessing.

Filing for bankruptcy when you’re in a financial bind is no fantasy; it’s something millions of Americans must resort to each year. In the event that you think you need to declare bankruptcy, here are a few things to consider before taking the plunge.

Explore your options

It’s very important to understand that just because you’re in debt doesn’t mean bankruptcy should be your first option. Depending on how much debt you’ve incurred, you may have a number of options available to you.

Debt Consolidation: Taking out a loan in order to pay for your other loans may seem counterintuitive, but it could mean lower interest rates and a single, steady road to financial revival. One effective way to consolidate your debts is to apply for a balance transfer card. These allow you to move your debt from other credit cards into one place so you can consolidate your payments and whittle away your debt without interest for a time. However, keep in mind that most credit cards charge 3-5% of however much you transfer.

Work with a Credit Counselor: You can try to take control of your debt situation with the help of a credit counselor. They’re there to help you get organized and come up with effective strategies to slowly pull yourself out of debt. Usually they can offer solutions to your financial woes, but if not, they can at least properly assess whether or not filing for bankruptcy is the right option for you.

Still in trouble?

If you’ve exhausted these options and still find yourself in a bind, it’s important to know exactly how bankruptcy works and how it will affect you. First and foremost, filing for bankruptcy significantly lowers your credit score—somewhere between 130 and 240 points. When you file for bankruptcy, it remains on your credit report for 10 years, making it difficult to get any credit or to make big purchases, like a house or a car, for a very long time.

It costs about $1,500 to even start the filing process and you’ll need to do pre and post bankruptcy counseling on your dollar, according to the amendments to the law made in 2005.

Next, you need to consider which kind of bankruptcy you’d like to file: Chapter 7 or Chapter 13. Chapter 7 bankruptcy will wipe out all of your debts except for child support, alimony, student loans, and income tax debt, to name a few. Be sure to check if your debt can be lifted to avoid filing and ruining your credit score for no reason. You will be required to take a means test to see if you qualify for Chapter 7 bankruptcy or if your income is steady enough to gradually pay off your debts. It also stays on your record for 10 years, so make sure it’s the best option.

Chapter 13, on the other hand, allows you to pay off some of your debts over a 5-year period. You are assigned a payment plan that works with your current, stable income, and are given a little bit more breathing room. This stays on your record for 7 years—shorter than Chapter 7, but just as hard on your credit score.

Never Do It Alone

The best advice one could give is to never try to do this alone. There are plenty of sites claiming to help you avoid lawyer fees by declaring bankruptcy on your own, but the truth is, it just isn’t worth it. There is so much that could get lost or confused in the entire process that you may end up in a bigger jam than before. Find a credit counselor or a lawyer well versed in credit card debt to help you get through the process with as little damage as possible.

Bankruptcy should always be your last resort. It may be devastating to start, but it could eventually end up being your one lifeline when you need it most.

Tim Chem is the founder and CEO of NerdWallet, a website dedicated to helping consumers find the best credit cards.