A bankruptcy will have a significant impact on your credit score for up to ten years. But preserving your credit score isn’t as important as having a place to live and keeping food on the table, which is why filing for bankruptcy is a practical option for some people. As with any big decision, though, before you decide to file—or not to file—for bankruptcy, you should do your homework. Start by reviewing alternatives to bankruptcy. Consider these options, which are less drastic measures and have less dire consequences than declaring bankruptcy, before you file. Depending on your finances, the type of your debts, and your financial goals, a non-bankruptcy option might be your best choice.
The first option to think about is whether you can modify your lifestyle so that you can put more money toward paying off your debts. Start by making a budget. Taking a look at your income and expenses will give you a clear picture of your financial situation. Through the budgeting process, you’ll see where you can make adjustments so you can find savings. Consider lifestyle changes to pay down what you owe and avoid bankruptcy. For example, do you really need some of your extras, like streaming services, a daily latte, or a gym membership? Cut out these nonessentials and use the saving to bring down your debt. You might also think about refinancing your mortgage when interest rates are low. Or you could downsize to less expensive housing, like a smaller home or rental. Use the money you save to pay off your debts.
If you need help with the budgeting process or getting ideas on how to save money, you can get assistance from a no-cost or low-cost nonprofit credit counseling agency, like one affiliated with the National Foundation for Credit Counseling (NFCC).
If you have some income, savings, or assets you're willing to sell, you could negotiate with your creditors to reduce your debts rather than filing for bankruptcy. Many creditors will agree to settle debts for less than is owed.
Settling your debts for less than you owe or working out a repayment agreement is similar to what happens in a Chapter 13 bankruptcy, but won’t hurt your credit as much. A negotiated debt will still show up as settled in your credit history—unless you work out a deal for the creditor to report it differently—but a settled debt harms your credit far less than a bankruptcy does. If you’re uncomfortable negotiating with creditors on your own, you can seek help from a nonprofit credit counseling agency. Be sure to choose a legitimate counseling agency. Avoid for-profit debt settlement and credit repair scammers. Or get help from a debt settlement lawyer.
For some people, the best move is to do nothing at all. If you're living simply, with little income or assets, and don’t think your financial circumstances will change, you might be what's known as "judgment proof." Being judgment proof means that most creditors can’t get anything from you—even if you don’t file for bankruptcy.
Participating in a debt management program through a nonprofit credit counseling agency is similar to filing for Chapter 13 bankruptcy. The agency helps you come up with a plan to pay back your creditors over time, kind of like a Chapter 13 plan. You make one lump payment every month to the nonprofit agency (again, avoid for-profit operations), which then sends the money to your creditors. With a debt management program, the agency might be able to get your creditors to waive or reduce finance charges or fees. Generally, nonprofit agencies provide these services at no or low cost to clients.
The main benefit of entering into a debt management program is that it won’t have any additional adverse effect on your credit score. The negative items in your credit report associated with the overdue debts will be reported for just seven years, instead of up to ten years for a bankruptcy. And your credit reports won't show a bankruptcy, though they will contain a note that you enrolled in a debt management plan. If you make timely payments as part of the plan, you might even see a positive impact on your credit score because your payment history accounts for 35% of a FICO credit score. Also, the decline in the amount you owe could cause your score to rise because your utilization ratio (how much of your available credit you use) makes up 30% of a FICO credit score.
But debt management programs also have significant disadvantages compared to a Chapter 13 bankruptcy. If you miss a payment, Chapter 13 protects you from collection actions. A debt management program doesn’t provide this protection. Also, you might have to pay your debts in full under a debt management program. With a Chapter 13 bankruptcy, you often pay only a small fraction of your unsecured debts. Finally, debt management and debt settlement scams are common. Scammers know that people in financial distress often make desperate or bad choices. You need to be careful and do research on the company you’re dealing with before you sign up for a plan. Make sure the company is accredited and consider using an agency that’s a member of the NFCC. Also, be sure to avoid debt elimination scams, for-profit debt settlement companies, credit repair schemes, payday loans, auto-title loans, student loan scams, and get-rich-quick plans.
Even if you think one of these options is best for you, consider scheduling an initial consultation with a lawyer to learn what filing for bankruptcy can and can’t do in your situation.