What Is the Downside of Filing for Bankruptcy?

By Julija A.

June 19, 2023

If your sources of income are compromised and you’re unable to pay your debts back, you might consider filing for bankruptcy. Bankruptcy may look like the only way to get a breather, but before you do that, you must understand what the consequences of such an action could be.

So, what is the downside of filing for bankruptcy? We will discuss that in this article, so read on.

What Is Bankruptcy?

Bankruptcy is a legal process that can be initiated when a person or business entity is financially unable to settle debts. When an individual or company files a petition for bankruptcy, the court evaluates their assets. If the assets are deemed to be of enough substantial value, they can be sold off to pay off some of the debt.

The relationship between bankruptcy and debt is a serious one. Filing for bankruptcy is a negative implication regarding your ability to pay back future debts and it affects your credit score, so you shouldn’t resort to it lightly.

To properly utilize bankruptcy in debt settlement, you should first know what types of bankruptcy exist.

Types of Bankruptcy

There are two types of personal bankruptcy you should consider when it comes to debt settlement. In most cases, it is either a Chapter 7 or Chapter 13 filing. For businesses, there’s Chapter 11.

Chapter 7

Most people tend to file a Chapter 7 when it comes to bankruptcy and debt. Filing for a Chapter 7 bankruptcy usually does not result in your property being sold to cover portions of your debt, but it is still a possibility depending on the specifics of the case. The filing takes three to five months.

Chapter 13

A Chapter 13 bankruptcy is usually filed to enable reorganization. This means that you seek some time to plan out how your debt settlement will go. It’s the less common type of bankruptcy filing. Your property or assets are not going to be sold to pay off debts, but this filing requires that you and your creditors agree to a repayment plan bound by the court. 

Chapter 11

This bankruptcy filing isn’t that much different from a Chapter 13 filing. They both involve reorganization, but while Chapter 13 is meant for individuals, Chapter 11 is applied to business interests. It is more complex than any other type of bankruptcy and gives businesses in serious debt the chance to keep operations running, while they restructure to pay off their creditors.

The cost to file a bankruptcy varies, but on average, you would be looking at around $1,500-$4,000. These cover court filing and attorney fees.

Now that we’ve considered the most common types of bankruptcy, let’s look at the pros and cons of bankruptcies.

Benefits and Downsides of Filing for Bankruptcy

Filing for bankruptcy can be a good thing, but it can also have many disadvantages. Here’s what you can gain or lose from filing a Chapter 7, 11, or 13.

Pros

Filing for bankruptcy can help you save your property or assets from being sold off to settle debts. It’s a second chance for you to handle debts without throwing your life into disarray.

Bankruptcy is a useful tool for relieving you of the legal obligation to pay off a credit facility, taking pressure from creditors off you until you’re able to reorganize your finances.

A bankruptcy filing can help your business stay in operation even when you can’t repay debts. It’s a good way to protect the income in your business checking account.

Cons

On the other hand, filing for bankruptcy can lower your credit score rating. This is one of the biggest drawbacks of bankruptcy. How low your rating can drop depends on your score. A good credit score rating is estimated to drop by up to 200 points, although the effect is less severe the lower the credit score is.

Bad credit scores, in turn, have several financial implications. It would be difficult to qualify for loans, mortgages, credit cards, or to even purchase or rent a property. If you do qualify for a loan, your interest rates would be much higher. However, there is a way out, as you could apply and get loans even with a bad credit score.

Bankruptcy Consequences

Bankruptcy may be a second chance, but it could also be a financial nightmare. For one, they stay on your credit report for a long time. Chapter 7 bankruptcies stay on credit reports for about 10 years, while Chapter 13 bankruptcies stay for about 7 years. 

Even so, the negative impacts are reduced over time, especially since filing for bankruptcy usually means some of your debt is written off.

Alternatives to Bankruptcy

Before you jump straight to filing for bankruptcy, there may be other ways to handle your debt problems.

Debt Settlement

With debt settlement, creditors agree to accept a large portion of your debt in order to settle the full balance. It is only applicable in situations where you have defaulted repayments. You can try and negotiate with your debtors on your own, or hire a debt settlement company.

Debt Consolidation

With debt consolidation, you combine various debts into one payment. You typically get more favorable interest rates and can settle debts more quickly. However, it requires you to have a credit line or a loan that you can use to pay off these debts.

Credit Counseling

This plan involves turning to credit counselors, who can help you devise a plan to manage your debt and pay it off in affordable installments. Credit counselors can reach agreements with creditors to lower interest rates and payments, so you don’t need to file for bankruptcy. However, their services are not free.

Conclusion

As tempting as it may be to jump on the bankruptcy train, it’s wise to consider if the repercussions of filing a bankruptcy are worth it. You should always keep in mind that there are alternatives, such as borrowing from family, selling off certain properties, or looking for additional sources of income. Even a change in your lifestyle can be enough for you to avoid bankruptcy in some cases.