The last debt resort -- bankruptcy
Christy Heady • Bankrate.com

When should you bail out?

Financial troubles have led millions of Americans to file for bankruptcy, often using the process as an "alternative." How wrong. Filing for bankruptcy is the last resort to your financial woes, not a choice. If you are in debt and need to file, however, there are pitfalls you can avoid.

Most often, you don't have to file unless it's necessary -- declaring yourself bankrupt is not an alternative, it's a necessary solution. One bankruptcy attorney in Chicago claims that he has yet to see a situation where the filing was not required.

If you are having difficulty meeting your rent or mortgage payments, you're completely extended beyond your credit limit, the collection agencies are uncooperative and you need more than a credit counselor, you may need to file a "Chapter 7" or a "Chapter 13."

Chapter 7 and Chapter 13 are the two basic ways of filing for personal bankruptcy. Chapter 7 gets rid of all debts (except some taxes and maybe alimony payments); Chapter 13 allows you, when in debt and with a steady income, to pay off your bills over a 36- to 60-month period.

The first thing you should do is seek the advice of an attorney, who will guide you into which bankruptcy proceeding you should file, according to your personal debt situation.

What happens when you file

Here's how they work. When you file either Chapter 7 or Chapter 13, you are issued a restraining order by the court which will protect you from all further proceedings against you until all previous debts are cleared. The restraining order includes protection against wage garnishing, creditor harassment, and foreclosures without a court order.

Chapter 7 is for people who have few or no secured debts -- that is, loans that are backed by collateral. Credit card debt is unsecured debt, and most people who file Chapter 7 are drowning in credit card debt. By declaring Chapter 7, those unsecured debts are forgiven. Chapter 7 debtors can sign a "reaffirmation agreement" that allows them to keep paying some types of secured debt, such as auto loans.

Chapter 13 is for people with substantial secured debt. In most cases, that means they have home mortgages. Under Chapter 13, homeowners can stay in their houses while paying their debts under a court-supervised spending plan that lasts three to five years.

Regardless of chapter, a debtor is almost always required to pay federal taxes and student-loan debt.

The bright side to filing for bankruptcy is immediate relief. The dark side is a black mark that remains on your credit record to haunt you for 10 years.

But all is not lost. It is still possible to potentially establish a "new" credit record and obtain a credit card: a secured credit card. Some companies that offer secured credit cards have guidelines that are a bit more flexible.

Posted: May 21, 1998