Overwhelming debt can be stressful, and sometimes, there’s no easy way to get out of it. In those cases, bankruptcy may seem like the only way out. While it can offer a fresh start by wiping away certain debts, it’s a serious financial decision with long-term consequences.

So, when is bankruptcy the right option? Understanding the different types of bankruptcy, what it involves, and when it might be the right choice for you can help you make an informed decision.

1. What is bankruptcy?

Bankruptcy is a legal process designed to help individuals or businesses that can’t repay their outstanding debts. When you file for bankruptcy, a court will review your financial situation and determine whether to discharge your debts, allowing you to start fresh financially. The process is governed by federal law and aims to provide relief to the person who owes the money, while ensuring fairness to creditors.

There are different types of bankruptcy, and each one works differently and has its own implications. The most common types for individuals are Chapter 7 and Chapter 13.

  • Chapter 7: Also known as “liquidation bankruptcy,” Chapter 7 allows you to discharge most of your unsecured debts, like credit card balances and medical bills. In exchange, you may be required to sell certain assets to repay creditors. Many personal belongings —including clothing, household items, and a portion of home equity—are usually exempt from liquidation.
  • Chapter 13: Also known as “reorganization bankruptcy,” Chapter 13 allows you to develop a repayment plan to pay back all or part of your debts over three to five years. This type of bankruptcy is often used by people who want to keep their property, like their home or car, while repaying their debts through a structured plan.

2. Signs that it might be the right option

Bankruptcy is a serious financial step and should be considered only after exploring all other alternatives. Here are some signs that bankruptcy might be the right option for you:

Overwhelming debt

If you have so much debt that you can’t realistically repay it, even with a significant change in your financial circumstances, bankruptcy might be a viable option. This is especially true if your debts are primarily unsecured, such as credit card balances, medical bills, or personal loans.

Brigit tip: Calculate your debt-to-income ratio by dividing your total monthly debt payments by your gross monthly income. If your ratio is higher than 50%, you may be struggling with unsustainable debt.

Constant harassment from creditors

If you’re constantly getting calls, letters, or even threats of legal action from creditors, filing for bankruptcy can bring relief. Once you file for bankruptcy, an automatic stay goes into effect, temporarily halting most collection efforts, including phone calls, wage garnishments, and lawsuits.

Brigit tip: Keep records of all communication with creditors. If their harassment becomes overwhelming or abusive, talk to a bankruptcy attorney to learn about your options.

Risk of foreclosure or repossession

If you’re at risk of losing your home to foreclosure or your car to repossession due to missed payments, bankruptcy might help you keep these assets. Filing for Chapter 13 bankruptcy can provide a structured repayment plan that allows you to catch up on missed payments and avoid foreclosure or repossession.

Brigit tip: consider Chapter 13 bankruptcy if you have a regular income and want to keep your home or car while repaying your debts.

No other viable debt relief options

Before considering bankruptcy, it’s important to explore your other debt-relief options, like debt consolidation, credit counseling, or negotiating directly with creditors for a debt settlement. If these options aren’t feasible or you’re unsuccessful in negotiating them, bankruptcy may be your best course of action.

Brigit tip: Consult a credit counselor or financial advisor to explore all your options before filing for bankruptcy.

Mounting medical debt

Medical expenses are a leading cause of bankruptcy in the United States. If you have significant medical debt and no realistic way to pay it off, bankruptcy can provide relief. Chapter 7 bankruptcy can discharge most medical debts, so you can focus on recovering your health instead of financial stress.

Brigit tip: If medical debt is the primary reason you’re considering bankruptcy, check to see if any assistance programs or charity care options are available through your healthcare provider.

Wage garnishments or frozen bank accounts

If your wages are being garnished or your bank accounts have been frozen due to unpaid debts, bankruptcy can help. Filing for bankruptcy stops most wage garnishments and releases any bank account freezes, providing immediate relief.

Brigit tip: Act quickly if you’re facing wage garnishment or bank account freezes. The sooner you file for bankruptcy, the sooner the automatic stay goes into effect.

3. When it might not be the right option

While bankruptcy can provide relief in some situations, it’s not always the best choice. Here are some scenarios where bankruptcy might not be the right option:

Debts that are not dischargeable

Not all debts can be discharged through bankruptcy. For example, student loans, child support, alimony, certain tax debts, and debts as a result of fraud usually can’t be discharged. If your debt is mostly made up of these non-dischargeable debts, bankruptcy may not provide the relief you’re seeking.

Brigit tip: Talk with a bankruptcy attorney to understand which of your debts are dischargeable before filing.

You have significant assets at risk

In a Chapter 7 bankruptcy, some of your assets may be sold to repay creditors. If you have significant non-exempt assets, like a second home, valuable jewelry, or investments, you could lose them in the bankruptcy process. In this case, you might want to consider other debt-relief options.

Brigit tip: Chapter 13 bankruptcy may be a better option if you have assets you want to protect while repaying your debts.

Your financial situation is temporary

If your financial difficulties are due to a temporary setback, like a job loss or unexpected medical expenses, bankruptcy might not be necessary. In some cases, a temporary reduction in expenses or a short-term loan from a family member can provide the relief you need without the long-term consequences of bankruptcy.

Brigit tip: Consider whether your financial situation is likely to improve in the near future before deciding to file for bankruptcy.

You haven’t explored other debt-relief options

Before you file for bankruptcy, it’s important to explore other debt relief options, like debt consolidation, debt settlement, or working with a credit counseling agency. Bankruptcy should be considered a last resort when all other options have been exhausted.

Brigit tip: Contact a credit counseling agency to discuss your debt relief options and determine whether bankruptcy is the right choice for you.

4. Long-term consequences

While bankruptcy can give you a fresh start, it comes with long-term consequences that you should consider before filing:

  • Credit ccore impact: Bankruptcy will remain on your credit report for up to 10 years, depending on the type of bankruptcy filed. This can make it more difficult to obtain credit, secure a mortgage, or even rent an apartment.
  • Difficulty obtaining credit: After filing for bankruptcy, you may face higher interest rates and stricter terms when applying for new credit. It can take time to rebuild your credit score and financial reputation.
  • Loss of assets: in Chapter 7 bankruptcy, some of your assets may be sold to repay creditors, which could result in the loss of property, vehicles, or other valuable possessions.
  • Public record: Bankruptcy filings are a matter of public record, which means that anyone can access this information.

5. Consulting a bankruptcy attorney

If you’re considering bankruptcy, it’s important to consult with a qualified bankruptcy attorney who can provide guidance based on your specific situation. An attorney can help you understand the different types of bankruptcy, the pros and cons of each option, and whether bankruptcy is really the best solution for your financial needs.

Brigit tip: Look for an attorney who specializes in bankruptcy law and offers a free initial consultation. This can help you understand your options and make an informed decision.