Can’t afford car. File for bankruptcy?

Dear Debt Adviser,
I have $10,000 in debt — $1,900 in credit card debt, $6,000 in a car loan and the rest miscellaneous. I can pay off the credit cards and the miscellaneous debt, but the car loan is just too much. So, I was wondering what would be best to do. Should I go bankrupt, pay off the credit cards and the miscellaneous debt, or not do anything? Also, how will it affect my credit report and score if I do go bankrupt?
— Eva

Dear Eva,
I can tell from your questions that despite the fact that you live with credit every day, you and credit reporting are still strangers. You have a lot of company, so don’t feel bad. Misinformation about credit gets passed around so much that many erroneous ideas have become accepted as truth. So you may be misinformed, but you are smarter than the average Gen X-er or Gen Y-er because you are asking for help before you take action.

On the face of what you have told me, bankruptcy may not be a viable option to solve your problem. While you might get rid of the $4,000 in unsecured debt, you would need to reaffirm your $6,000 car debt or lose the car and any money you have paid on it so far. If you kept the car, you would still have to make the payment. If you decided to give up the car in bankruptcy, you may pay much more because of your bad credit when you buy a replacement, even if it was for less money.

In my book, $10,000 is nowhere near enough to warrant a bankruptcy. I suggest that you save the bankruptcy option as a last resort, if only because once you do it you will have severe repercussions to your credit, future loans, job prospects and insurance costs! Phew! I’d rather see you get a second, part-time job to pay off the balances you owe.

A better option for you may be to sell your car and purchase one that you can afford. Of course, if you are upside down in your loan (owe more than your car’s value) you will need a plan to deal with any shortfall if you decide to sell your car. If you are $1,000 or less upside down, it may be better to sell the car yourself and pay the difference in your loan rather than paying off your credit cards. Selling your car and buying a cheaper one will keep your credit intact and allow you to finance the replacement car at a reasonable rate. If you owe more than you can cover, look into a trade-in at a low interest rate.

I want you to take a realistic look at all your finances and come up with a spending plan that has you living within your means — spending less than what you earn — and socking some money away in savings for emergencies.

To begin, stop using credit to extend your income. In other words, don’t buy it if you can’t pay it off at the end of the month. Next, include a monthly amount to pay down your unsecured debt in three years or less. Finally, add up your fixed monthly expenses (rent or mortgage, utilities, insurance) as well as your discretionary expenses (food, clothing, entertainment) and subtract the amount from your take-home pay. Once you have a good idea of how far your income will stretch, you will know how much you can realistically afford to pay for transportation.

If you need help developing or balancing a spending plan, check out, a Web site run by the National Foundation for Credit Counseling. They have a great budget work sheet you can download. Plus, if you have credit or budgeting questions, the site can put you in touch with an accredited nonprofit agency that specializes in providing that kind of information … for free!

To answer your question regarding any impact to your credit report and credit score, a Chapter 7 bankruptcy would be major negative — figure at least a 100-point drop — and it would be on your credit report for the next 10 years.

Good luck!

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