5 Things to Know Before Filing Bankruptcy

Managing finances can be tough. Sometimes it feels like you're neck-deep in quicksand and declaring bankruptcy might look like exactly the lifeline you need.

But, hold your horses! Bankruptcy isn't a “Get Out of Jail Free” card. While it can provide relief from some of your more immediate debts, it could have lasting effects on your finances for the years to come.

So let’s look before you leap, by walking through five key pointers that'll help you figure out if bankruptcy is the right path for you.

1. You Still Need to Pay at Least Some of Your Debt

Heard that filing bankruptcy is like pressing a magic reset button on your debt? Not exactly.

Chapter 7 and Chapter 13 bankruptcies can eliminate unsecured debts like credit cards and they can halt repossessions, foreclosures, and debt collector actions, but other debts like child support, alimony, or tax dues will stick around. You may be able to discharge your student debt through bankruptcy if you have federal loans, but you'll have to take additional steps since the debt is treated differently.

Chapter 7 bankruptcy requires you to sell off your personal property, which isn’t protected by an exemption, in order to pay down your debts, so it can be a decent option if you don’t own any valuable assets like a house or a car, but it’s still no picnic. On average this takes 3-4 months but could take up to a year, and you’re required to allow a federal court trustee to go through and sell any eligible assets to repay some of your debts. The upside here is that this type of bankruptcy will completely wipe away most unsecured debts, like credit cards and medical bills.

Chapter 13 bankruptcy, on the other hand, lets you keep your property, but you have to commit to repaying the debt, either in full or in part. It comes with a repayment plan agreed upon by your attorney and the court, spanning 3-5 years. Not a walk in the park, but it does alleviate some of that financial anxiety by lowering your payments. After the agreed time, the court tosses out the unsecured debt, even if it's not fully paid off.

2. You'll Need to Attend Credit Counseling

The road to bankruptcy requires a pit stop at credit counseling classes within 180 days of filing. Here, a government-approved organization will run an eye over your finances, brainstorm alternatives to bankruptcy, and help you create a personal budget plan.

Once you've done the homework, you'll earn a certificate. No certificate, no filing for bankruptcy. If that sounds intimidating, don’t worry!

3. Chapter 7 Requires a Means Test Pass

Qualifying for personal bankruptcy Chapter 7 is like going through a financial hoop. You must pass a means test, which basically means the government needs to check that you don’t make too much money. If you're in Virginia, for instance, you've got to make less than $67,918. If you make more than that, sorry, Chapter 7 is off-limits. But all hope is not lost! In most cases, you can still qualify for Chapter 13.

4. Making Big Money Moves before Filing Might Backfire

Don’t try to be sneaky and pull a fast one on Uncle Sam! Making big changes to your finances before or during your bankruptcy filing might throw a wrench in the works. It might seem like a good idea to transfer substantial sums of money or assets, sell property, cash out retirement funds, or accumulate more debt, but that might actually get your filing application tossed out.

If you go wild on a spending spree, creditors can scream "fraud!" and your bankruptcy request might hit the wall. Bankruptcy trustees can also reverse any sale or transfer of property and use it to pay off debt.

5. Bankruptcy Is No "Get Out of Jail Free" Card

Bankruptcy is no fairy godmother waving a wand to fix everything. Chapter 7 can haunt your credit for 10 years and Chapter 13 for 7. Some might shrug it off as a small price for squashing overwhelming debt, but others might need to mull over the financial implications.

Bankruptcy could send your credit score into a nosedive, making it harder to get approved for loans, credit cards, and leases. Mortgages or personal loans might seem out of reach, or come with steep interest rates and unfavorable terms.

And here's the real kicker - bankruptcy becomes public record. Because it shows up on your credit report for years, it's also visible in background checks when applying for jobs or renting apartments.