When Bankruptcy Beats Continuing to Struggle With Credit Card Debt[yoast-breadcrumb]
When Bankruptcy Beats Continuing to Struggle With Credit Card Debt
If you’re like most Americans, you probably have some amount of credit card debt. According to a 2022 report from Experian, the average credit card debt per borrower is $5,221. While having credit card debt isn’t necessarily a bad thing – it can actually help build your credit if you make on-time payments – it can quickly become overwhelming if you let it spiral out of control.
So what do you do when your credit card debt becomes unmanageable? You have a few options:
- Try to pay it off on your own by cutting expenses and dedicating more money to paying down the debt each month
- Work with a nonprofit credit counseling agency to set up a debt management plan
- Consider debt settlement, where companies negotiate with creditors to settle debts for less than what you owe
- File for bankruptcy to eliminate credit card debt entirely
Each of these options has its own pros and cons. Paying off credit card debt on your own takes discipline but lets you avoid the impact on your credit. Credit counseling helps organize payments but takes years to complete. Debt settlement can reduce balances quickly but damages credit scores.
Bankruptcy, meanwhile, provides immediate debt relief but also comes with lasting consequences. However, there are times when the benefits of bankruptcy outweigh the drawbacks. Here’s a look at when bankruptcy beats continuing to struggle with overwhelming credit card debt.
How Bankruptcy Eliminates Credit Card Debt
There are two main types of bankruptcy for consumers – Chapter 7 and Chapter 13. Both can eliminate credit card debt, but in different ways.
Chapter 7 bankruptcy completely wipes out eligible credit card debt and most other unsecured debts. This is known as a “straight” or “liquidation” bankruptcy. First, you’ll have to pass the Chapter 7 means test to qualify. This looks at your income and expenses and determines if you have enough disposable income to repay some debt. If you pass, the court discharges your debts and creditors can no longer try to collect on them.
Chapter 13 bankruptcy, on the other hand, restructures debt into a 3-5 year repayment plan. You’ll make a single monthly payment to a trustee who distributes payments out to creditors. At the end of the plan, any remaining credit card balances are discharged.
Both types have their pros and cons, but the end result is the same – legal elimination of credit card debt. This can provide a fresh financial start if debt has become unmanageable.
When Bankruptcy Makes Sense for Credit Card Debt
Bankruptcy is a major decision with long-lasting impacts on your credit. It’s generally considered a last resort after exhausting other options. However, certain situations make bankruptcy the best choice over continuing to struggle with credit card debt:
You Can’t Keep Up With Minimum Payments
Credit card companies determine minimum monthly payments, usually around 2-3% of the balance. While minimums seem manageable at first, they become less affordable as the balance grows. If you find yourself unable to pay even the minimums month after month, bankruptcy may be your best option for finding relief.
You’re Relying on Credit Cards to Get By
When you have more month than money, credit cards can seem like an easy solution. But financing everyday expenses with credit cards digs you deeper into debt. If you use cards for necessities just to stay afloat, bankruptcy can break the cycle of dependence on credit.
You’re Juggling Debt Payments
Many people turn to credit cards to fill the gap when they don’t have enough income to cover all their bills. If you’re constantly robbing Peter to pay Paul and juggling debt payments, bankruptcy may help stabilize your finances.
You Have High-Interest Credit Card Debt
The higher your credit card interest rates, the harder it is to make headway on balances. Cards with rates above 15% make debt especially hard to repay. If much of your debt is on high-rate cards, bankruptcy could eliminate it entirely.
Your Debt Exceeds Your Assets
Those with more debt than assets who file Chapter 7 bankruptcy can often discharge it all. However, if you have assets creditors could seize, Chapter 13 may be a better option to protect property.
You’ve Had a Financial Setback
Unexpected crises like job loss, reduced income, divorce, or medical bills can make credit card debt unmanageable. If a financial setback caused your debt spiral, bankruptcy may help you regain solid financial footing.
You Owe Debt to Many Creditors
The more accounts you have with unpaid balances, the harder it is to keep track of monthly payments. If you owe money to a multitude of creditors, bankruptcy consolidates all debts in one proceeding.
You’re Being Sued or Harassed by Collectors
Falling behind on credit card payments can result in lawsuits, collection calls, and harassment. Bankruptcy stops these actions and provides legal protections.
You Don’t Foresee Your Situation Improving
If your financial struggles are long-term and you see no end in sight, bankruptcy may provide the clean slate needed to rebuild your finances. Continuing to battle uphill against credit card debt you can’t repay only causes more harm.
The Benefits of Filing Bankruptcy for Credit Card Debt
Here are some of the biggest benefits of filing bankruptcy when you can no longer keep up with credit card payments:
- Immediate automatic stay. When you file, creditors must stop collection efforts right away.
- One monthly payment. Chapter 13 bankruptcy centralizes payments into one monthly plan payment.
- Elimination of debt. Chapter 7 bankruptcy discharges eligible debts, while Chapter 13 discharges remaining balances after the repayment plan.
- Time to catch up. The 3-5 year Chapter 13 repayment plan gives you time to get back on your feet.
- Keep property. Chapter 13 allows you to keep assets like your home and car by making ongoing payments.
- Rebuild credit. Once debts are eliminated, you can start fresh and focus on responsible credit use.
- Stop lawsuits and wage garnishment. The automatic stay stops any legal actions against you.
- Lower interest rates. Your repayment plan in Chapter 13 bankruptcy applies much lower interest.
- Get utilities turned back on. You can restore disconnected utility services after filing.
- Reduce stress. Eliminating unmanageable debt helps relieve financial stress and anxiety.
The Drawbacks of Bankruptcy for Credit Cards
Bankruptcy also comes with downsides to weigh when deciding if it’s the right choice:
- Bankruptcy stays on your credit report for 7-10 years, harming your credit scores.
- You may have to forfeit property if you can’t afford Chapter 13 plan payments.
- Your future borrowing ability may be limited after bankruptcy.
- Bankruptcy won’t discharge every debt – some bills like student loans and taxes remain.
- You must complete credit counseling before filing.
- Chapter 13 repayment plans last 3-5 years.
- You may have to pay more for insurance and loans after bankruptcy.
- Employers, landlords, and utilities can discriminate against applicants with recent bankruptcy.
- Court permission is required for major financial decisions after filing.
- You may have to surrender luxury property and non-essentials.
Alternatives to Bankruptcy
Before deciding if bankruptcy is your best option, be sure you’ve explored alternatives like:
- Debt management plans – Nonprofit credit counseling agencies can negotiate lower interest rates and payments.
- Debt consolidation loans – Taking out a new loan pays off cards and combines debt into one payment.
- Balance transfer cards – Transferring balances to a 0% intro APR card defers interest for a time.
- Debt settlement – Debt settlement companies negotiate with creditors for a reduced lump sum payoff.
- DIY debt payoff – Make a budget, cut expenses, earn extra income, and pay as much as possible toward your highest-rate cards.
These options allow you to repay debt over time while avoiding bankruptcy. However, they may not provide enough relief if your debt has become truly unmanageable.
Is Bankruptcy the Right Choice?
Here are some signs bankruptcy may be your best path forward:
- You’ve missed multiple payments and can’t keep up with others
- Creditors refuse to negotiate affordable monthly payments
- You’ve liquidated assets but still can’t pay off debt
- You’ve cut expenses to the bone but still struggle with payments
- Your balances continue growing despite your best efforts
- You’ve used up retirement savings trying to pay down debt
- You’re relying solely on credit cards to pay for necessities
- Debt collectors are calling or suing over unpaid cards
- You can’t qualify for balance transfer or consolidation options
- You’ve tapped out all other sources of help like family and charity
If you identify with multiple signs of unmanageable credit card debt, meet with a bankruptcy attorney to discuss your options. They can provide guidance on whether bankruptcy is your best path forward.
The Bankruptcy Process
If you decide bankruptcy is the right choice, understand that it’s a court-supervised legal process with many steps:
- Meet with an attorney – Consult with a bankruptcy lawyer to discuss your specific situation.
- File paperwork – Your attorney will help prepare and file all necessary bankruptcy forms.
- Attend 341 meeting – You’ll meet with the trustee and creditors at a 341 hearing where you’ll answer questions.
- Complete pre-discharge steps – You’ll need to finish things like the credit counseling course and financial management class.
- Receive discharge – The court grants a discharge order eliminating debts, providing immediate relief.
- Rebuild credit – Now you can start using credit responsibly and focus on improving financial health.
Having a qualified bankruptcy lawyer to guide you through the intricacies of the process is highly recommended. Try to avoid “bankruptcy mills” more focused on volume than personalized service.
Talk to a Credit Counselor First
Before deciding to file bankruptcy, experts recommend first meeting with an accredited nonprofit credit counseling agency. They can discuss options like debt management, provide budgeting help, and offer advice on dealing with creditors. If your situation is truly untenable, they’ll help you understand that bankruptcy may be your best remaining choice.
Speaking with a credit counselor can provide an impartial third-party perspective on your financial situation. They will help you understand all your options, not just bankruptcy. Here are some key things a credit counseling session can offer:
- Budget evaluation – Review income, expenses, and cash flow to see where money is going.
- Advice on prioritizing debts – Get help deciding which debts to tackle first based on factors like interest rates.
- Customized debt management plan – A DMP consolidates debts into one payment and negotiates lower interest rates.
- Alternatives to bankruptcy – A counselor may suggest options like balance transfers, debt consolidation loans, or DIY payoff plans.
- Support dealing with creditors – They can intervene with creditors to stop harassment and negotiate affordable payments.
- Housing counseling – If your home is at risk, a counselor can help you work with your mortgage company.
- Referrals for other assistance – They may connect you with legal aid, job training, public benefits, or other resources.
- Pre-bankruptcy counseling – If needed, they’ll issue a counseling certificate allowing you to file.
Nonprofit credit counseling provides judgment-free guidance. They’ll discuss pros and cons of all options to help you make an informed choice. If bankruptcy is your best path forward, an experienced credit counselor will help you accept that fact.
Questions to Ask a Credit Counselor
To get the most out of your credit counseling session, here are key questions to ask:
- What are all my debt relief options, including bankruptcy?
- How quickly can you provide relief from creditors?
- Will interest rates and fees be reduced in a DMP?
- Are there risks like credit damage or tax implications?
- How could this impact my credit scores?
- How much will credit counseling and/or a DMP cost?
- How long would I be in your debt management program?
- Could I do a hybrid plan with some debts in DMP and others paid off?
- Can you help me budget and manage money better?
- What other resources do you offer like housing counseling?
Get specifics on what credit counseling can and can’t do for you. A reputable agency will explain your options in honest detail. They won’t try to push you into a solution that’s not in your best interest.
DIY Credit Counseling
If you’re disciplined and organized, you may be able to do your own form of credit counseling using free tools:
- Review credit reports and scores using AnnualCreditReport.com and sites like Credit Karma.
- Analyze spending with Mint or by examining bank/card statements.
- Come up with a budget and debt payoff plan using pen and paper or Excel.
- Call creditors directly to request lower rates and payments you can afford.
- Consider balance transfer or personal loan options to consolidate higher-rate debts.
- Prioritize paying down highest-rate debts first using the avalanche method.
- Use sites like NerdWallet and Credit Karma for debt payoff calculators and other resources.
Self-directed credit counseling takes diligence but lets you take control of your financial situation. However, professional guidance provides experience and resources you likely lack. Don’t be afraid to seek help.
The Bottom Line
Speaking with an accredited credit counseling agency offers expert perspective on managing debt. They’ll help you understand if bankruptcy or other options like debt management plans are right for your unique situation. Get personalized advice on the path forward.