Signs Bankruptcy May Actually Work In Your Favor

Aside from Michael Scott's famous declaration of bankruptcy for all at Dunder-Mifflin to hear in "The Office," most Americans are likely unfamiliar with the nuances of what bankruptcy actually entails. Almost half a million Americans filed for bankruptcy in the 12-month period between June 2023 and 2024 (a notable rise over the previous year). It's a large number, certainly, but still a tiny fraction of the total American population, making it a fairly uncommon occurrence for the typical consumer.

The process of filing for bankruptcy generally gets a bad rap. Many people think of this as an embarrassing financial admission of failure. But the reality is that there are plenty of good reasons to utilize the bankruptcy mechanism that the American economic and legal system provides. It's not a throwing in the towel of sorts, but rather a lifeline to those who have fallen on hard times. John Oliver covered the process in an episode of "Last Week Tonight," noting that the conditions that push consumers to bankruptcy are commonly the result of bad luck. The process allows you to start fresh, unburdened by previously crushing debts. But it can be tough to understand if the process is right for you. Here's a few key signs that can help guide you to making that important and weighty decision.

First and foremost, bankruptcy is commonly a path taken after an accident, misfortune, or other crisis comes into your life and drastically changes your financial circumstances in a negative way. No matter what your financial health looks like today, a sudden emergency medical situation that sees you laid up in the hospital for days or weeks and then out of work for a month or longer can wreak havoc on your budget. An inability to work as a result of a spate of bad luck is a common spiraling scenario that sees people turn to bankruptcy. You may end up getting behind on credit card bills, student loan payments, or your mortgage obligation, potentially finding yourself in jeopardy of losing a key asset that keeps your life on track.

Bad fortunes, not recklessly irresponsible spending, are often behind a consumer's decision to utilize bankruptcy as a means to wipe the slate clean. The reality is that a large medical expense stacked on top of an already tenuous financial situation or one that can't handle a long outage at work is often enough to tip you over the edge and send you scrambling to find relief. Bankruptcy can be that lifeline to help you get back on your feet after a tragic misfortune of nearly any variety.

Tragedy has a way of seeping into numerous connected areas of life. An issue in managing one financial obligation can lead to trauma elsewhere with ease. Getting behind on a large credit card bill can eventually lead to other bills starting to stack up. Even a decent juggling strategy that sees your most important payments remaining in good standing — things like your car loan or mortgage — can't last forever when finances start to get too tight. Eventually you might find yourself behind on your mortgage and at risk of losing your home to foreclosure.

Whether it's the place you call home or another critical asset that helps you maintain your lifestyle (if you lose your car, for instance, you might not be able to get to work, further exacerbating the financial trauma), bankruptcy can help you protect it. When you file for bankruptcy, your assets are protected by an automatic stay. This means that creditors can't repossess or foreclose on the things you own but may be behind on paying off. Effectively, if you're at risk of losing your home, filing for bankruptcy will freeze a bank's ability to take it away from you, and similar protections exist across the spectrum of key assets. You may also be able to sell your home and pay off the bank (potentially keeping some of the proceeds) rather than losing it completely to foreclosure. Wages also can't be garnished to pay off creditors, allowing you to keep your salary payments protected throughout the process, too. This shield won't last forever, but it acts as an important defense in the short to medium term while you work to settle your financial troubles.

Bankruptcy isn't a "get out of jail free card" and it comes with certain consequences. But if you successfully negotiate a bankruptcy settlement and complete the payoff process that comes afterward, you will enter a new phase of financial wellbeing that offers a new level of financial health. Starting over without the baggage of previous debts can be a massively freeing feeling. Financial struggles act as a huge stressor on Americans today. As many as 80% of Americans are stressed over money worries, with nearly half of all participants in an APA survey reporting physical manifestations of that stress (via Duke University).

Alleviating the debt burden that keeps you worrying about your workload, ability to save for retirement, or capacity to provide key life experiences to your family like vacations or trips around your community is a wonderful thing. Many people chase after financial tools to help them make this dream a reality. Options like debt consolidation loans or even credit negotiations can help, but they aren't for everyone. Some people are best served by the established process of declaring bankruptcy and seeking to settle existing debts once and for all. The path ahead requires dedication and consistent financial management, but on the other side of a bankruptcy filing is smooth sailing if you see it through (and then carefully manage your finances afterward).

Bankruptcy isn't a monolithic concept, even though it might seem that way. There are actually many avenues for filing, and each process is unique in its structure and pathway forward. For consumers (non-business bankruptcies), Chapter 7 and Chapter 13 bankruptcy filings are the tools you'll need to explore. Chapter 7 bankruptcy is more common than Chapter 13, but that doesn't mean it's the better option for everyone seeking to alleviate their debt load. Chapter 13 bankruptcy takes longer (as many as five years to fully settle) and costs more, perhaps acting as guiding lights when considering why more people follow the alternative route through this process.

The essential difference is in what happens to your assets. A few months after filing for Chapter 7 bankruptcy you may be finished with the whole affair and look to the future with brighter eyes. However, the speed comes at a different cost. In this approach, you'll liquidate some of your assets to satisfy agreed upon settlement figures with creditors (this is often best for tax debts, credit card balances, and other similar obligations). Some of your assets are protected like a car that you need to get to work or your home, but if you own more than one of either asset you're certainly going to have to give it up. In a Chapter 13 bankruptcy, you'll develop a repayment plan to settle your debts while keeping your assets. You're likely to agree upon a settlement amount or work to catch up on key shortfalls on debt products like a mortgage, giving you a lengthy period of time to complete the settlement process. The approaches are totally different, so you'll need to understand what works best for your situation.

Finally, anyone considering utilizing the escape hatch that is bankruptcy will have to come to terms with the fallout. Eliminating debts that you can no longer handle through a repayment plan (via Chapter 13 bankruptcy) or a liquidation agreement under a Chapter 7 procedure brings about a freeing feeling. But that feeling may not last long if you plan on making important financial changes to your life in the months and years after completing a bankruptcy filing. The action can stay on your credit report for as many as 10 years, and it will take even the most aggressive credit repair plan at least a year to rebuild some semblance of decent credit.

You're likely to find it difficult to buy a home through any avenue besides an FHA loan for years after a bankruptcy, and purchasing a car will come with heightened interest rates in almost all circumstances. The same can be said for just about any lending product that you're still eligible to utilize. A borrower that discharges overbearing debts through bankruptcy can look to clearer skies ahead, but that comes with an understanding that taking a step back from the use of new lending products is going to become the new normal. If you're someone needing to utilize bankruptcy, that's entirely alright, but you'll also need to commit to a reduction or elimination of new credit product use for a while after the process is completed.