If your debts have grown beyond control and you feel there is no other way out, you may be wondering if bankruptcy is your only option.

A formal legal process, bankruptcy can absolve consumers of some of their debts or reorganize debt to be more manageable. Bankruptcy, however, is not the only way to address significant debt. Cutting your expenses and debt consolidation can often help avoid filing for bankruptcy.

Types of bankruptcy

There are two main types of bankruptcies for consumers to consider, each of which can make sense depending on a consumer’s financial situation.

Chapter 7 bankruptcy

With Chapter 7 bankruptcy, the property is sold, and the proceeds are used to pay off debts. This type of bankruptcy is usually pursued by consumers who do not earn enough money to repay their debts.

Chapter 13 bankruptcy

With a Chapter 13 bankruptcy, some unsecured debts may be forgiven. However, remaining debts are reorganized and set up to be repaid over a specific length of time (usually three to five years). This type of bankruptcy is often utilized by consumers who earn enough to repay their debts but need assistance and a fresh start.

How bankruptcy works

How your bankruptcy will play out depends on the type of bankruptcy you file. With chapter 7 bankruptcy, for example, a trustee is typically appointed to take over your property and assess it for resale. Property of value you own can and will be sold to raise money for your creditors. You may be able to keep important personal items and potentially even real estate since the rules regarding your chapter 7 bankruptcy vary depending on where you live.

By contrast, you usually keep your property when filing for chapter 13 bankruptcy. However, you need to earn a regular income and agree to repay most of your debts on a repayment plan approved by the courts. A trustee will work with you to collect payments, which they’ll use to repay your creditors according to the plan.

While bankruptcy can be a relief for consumers who can discharge some of their debts, not all debts can be discharged. Most tax debts cannot be discharged in bankruptcy. You also typically cannot discharge child support payments, alimony, most types of student loans, court fines, criminal restitution and amounts owed due to personal injury caused by driving under the influence.

Why someone would file for bankruptcy

Filing for bankruptcy is usually seen as a last resort, mostly due to the lasting impact filing can have on your finances. A recent bankruptcy can easily cause your credit score to plummet, making it difficult to purchase a home, buy a car or qualify for other types of loans. Filing for bankruptcy can also cause your insurance rates to go up.

However, consumers who file for bankruptcy usually do so because they cannot navigate their way out of a financial crisis on their own. While bankruptcy is a permanent and drastic move with many downsides, the process intends to get people on a sustainable path toward better finances.

Because debts can be entirely discharged throughout the process, filing for bankruptcy can be seen as a godsend for those who are truly struggling and have few other options, if any, to consider.

How to know if you should file for bankruptcy

If you are overwhelmed by your financial situation, you may want to consider bankruptcy as a way out. There are plenty of situations where it makes sense to file for bankruptcy despite the consequences.

Here are some reasons to consider filing:

  • You have so much debt that it would be impossible to pay it off during your lifetime.
  • You’ve experienced an extreme loss in income that makes it impossible to repay debts without any help.
  • You have been sued for an extraordinary amount of money you cannot repay.
  • Your financial situation is grim, and you need a fresh start.
  • Collections agencies and creditors are calling you around the clock and you need third-party help.

Does bankruptcy affect my credit?

Having bankruptcy on your credit report will hurt your credit. A bankruptcy will make it harder to get loans or credit in the future, and your rates will be higher. How long a bankruptcy stays on your credit report depends on the type of bankruptcy you file.

Chapter 7 bankruptcy can stay on your credit reports for 10 years, while Chapter 13 bankruptcy only stays on your reports for seven years. However, the impact on your credit score will lessen over time. For example, a bankruptcy filed last year will have a greater impact than a bankruptcy filed five years ago.

Tips to avoid filing for bankruptcy

Bankruptcy is a last resort for people with debts they cannot pay off through other means. That is one reason the credit penalty is so severe — if you can avoid bankruptcy, it is usually in your best interest. Here are a few tips to avoid filing for bankruptcy.

Cut your expenses

The first tip is to try and cut your expenses as much as possible. Reducing your expenses should free up money to redirect toward paying down your debt to avoid bankruptcy. This effort should include carefully reviewing your monthly bank statements to identify where your money is going and eliminate spending that is not a necessity.

Debt consolidation

Depending on the types and amounts of your debts, you might also consider debt consolidation. You might be able to consolidate your debts by applying for a personal loan and using the proceeds to pay off your other debts and avoid bankruptcy.

You can also work with a company that specializes in debt consolidation. If you work with a company, find one that has positive reviews and does not charge excessive fees.

Negotiate with creditors

You can also try negotiating with your creditors to see if they will accept an alternative payment plan. Some creditors may be willing to work with you if it means they’re more likely to recoup the money owed. If your debt has already been sold to a debt collection agency, you may be able to negotiate a settlement amount with the agency.

Credit counseling

Many non-profit debt counseling companies can help you sort through your financial situation to help you develop a debt management plan. These agencies may also attempt to negotiate with your creditors on your behalf and help to obtain lower interest rates.

The National Foundation For Credit Counseling provides guidance on selecting a legitimate counseling company. It’s important to shop around and ask questions before agreeing to work with a specific company. Some questions to ask include whether an independent third party accredits the company, what fees they charge and whether counselors are certified.

Get a second job

If you’ve reduced your expenses as much as possible, another option is to increase your income. This could include getting a second job or working more hours at your current place of employment. You could also choose to sell items to generate some additional income. No matter which option you choose, use the extra income toward paying off your debt as quickly as possible.

Next steps

If you aren’t sure which move you should make next, you may want to spend some time comparing all your options. Learn about the types of bankruptcy, what it takes to file and consider all the bankruptcy alternatives you could pursue instead, along with their pros and cons.

A credit counselor can also help you determine how bad your financial situation is and if you could potentially reorganize your finances yourself. At the very least, a highly qualified credit counselor could help you get another perspective on your situation and determine whether bankruptcy is right for you. Many bankruptcy attorneys offer a free consultation to help you figure out your next best steps.