Don’t think you’ll ever pay off that credit card debt? Are collection agencies constantly buzzing your phone? Do you lie awake each night worried about the money you owe? You might think that filing for bankruptcy is a way to make these problems disappear.
But here’s the truth – bankruptcy comes with its own set of problems and some are severe.
It’s important to understand the long- and short-term impact of filing for bankruptcy protection. Filing will destroy your credit and make it more difficult to qualify for loans and credit cards. And if you do qualify for future credit, it could come with higher interest rates. A bankruptcy on your credit report could also make it more challenging to land a job you covet.
It’s why many financial experts advise consumers to consider their options carefully before filing for bankruptcy.
“I always recommend bankruptcy as an absolute last option,” said Leslie Tayne, founder of Tayne Law Group in Melville, New York. “There are other options. There are often better options. Your credit will be ruined for some time if you file for bankruptcy. You need to keep that in mind.”
Consumers generally file for one of two forms of bankruptcy – Chapter 7 and Chapter 13. In a Chapter 7 bankruptcy, your debts will be eliminated. But you’ll often lose your most valuable assets – including your home and car – to help pay off these debts.
In a Chapter 13 bankruptcy, a judge will create a repayment plan that allows you to pay back some or all of your debts at a pace, and with a monthly payment, that you can afford. Creditors might be willing to forgive some of the debt that consumers owe. Chapter 13 will also stop those phone calls from collection agencies, as long as you keep up with your court-ordered payments.
Both forms of bankruptcy protection will trash your three-digit FICO credit score. How much your score falls depends upon what your score was before you filed, but you can expect it to drop by as many as 150 points or more.
That’s a serious issue. Lenders rely heavily on your credit score when determining if you qualify for loans or new credit. If your score is too low, you won’t qualify. Even if you do qualify, you can expect to pay high interest rates, making borrowing money more expensive.
Bankruptcies don’t disappear quickly, either. A Chapter 13 bankruptcy filing remains on your credit report for seven years. A Chapter 7 filing stays there for 10, though the impact of these negative marks lessen over time if you start a new history of paying your bills on time and not running up new debts.
“That bankruptcy filing can follow you around for a decade,” said Scott Sadar, executive vice president with Somerset Wealth Strategies in Portland, Oregon. “Everything will be much more difficult during this time. It’s not a magic wand that simply makes creditors and harassing phone calls go away. It leaves you with a bad mark on your credit history going forward.”
It Follows You
Lenders will be wary of working with you if you have a recent bankruptcy on your credit report. You won’t even be able to apply for a mortgage loan guaranteed by Fannie Mae or Freddie Mac for the first two years after your bankruptcy becomes official.
There’s also a mandatory waiting period for mortgage loans insured by the Federal Housing Administration, better known as FHA loans. The FHA makes most borrowers wait a year before they can apply for a mortgage that it insures.
“Every financial aspect of your life is going to be affected by a bankruptcy filing,” said Anthony Criscuolo, portfolio manager with Palisades Hudson Financial Group in Fort Lauderdale, Florida. “You’ll struggle to borrow money. You’ll have a hard time getting credit. You’ll have to figure out how you are going to live in the next seven to 10 years with that bankruptcy filing following you around. That can be daunting.”
If you lost your home in your bankruptcy filing, you’ll probably try to rent an apartment, at least until you can rebuild your credit score. But even this can be a tougher task, Criscuolo said. Most landlords run your credit. If they see a bankruptcy on your credit report, they might require a higher security deposit. Some might not even rent to you.
Buying a new car, unless you are paying for it with cash, will also be a struggle. Auto lenders might reject your application if they see a bankruptcy on your report. Those that do lend to you, will hit you with higher interest rates. That makes getting a new car a much more expensive proposition.
Criscuolo said that even getting a new cell phone plan will be tougher. Service providers will also check your credit, and might hesitate to work with consumers with bankruptcies on their record. Why? They’re worried that such consumers, because of their past financial troubles, will be more likely to not pay their bills each month, Criscuolo said.
“You might have to live as a cash consumer for the next 12 to 24 months after filing for bankruptcy,” Criscuolo said. “That is challenging to consumers who have grown so used to using credit.”
More Expensive Car Insurance
A bankruptcy filing might also increase how much you pay for vehicle insurance. Insurers use what are known as credit-based insurance scores that help them determine how likely you are to file a claim. Studies show that drivers with lower scores tend to file more claims. Insurers can charge these motorists higher rates to protect themselves.
If you have a recent bankruptcy in your past, your credit-based insurance score will be lower, and you can expect your auto insurance payment to be higher.
Keeping You From a Better Job
A bankruptcy filing might even keep you from landing that new job, though this is a bit complicated.
Potential employers can’t check your credit score. But they can order what is known as an employment screening. This is a summarized version of your credit report. But unlike the credit reports maintained by TransUnion, Experian and Equifax, this report doesn’t contain all of your personal information. It will, though, list Chapter 7 bankruptcies that are less than 10 years old and Chapter 13 bankruptcies that are less than seven.
Tayne said that these filings might cause employers to pass you over for a job, especially if you are applying for a position in finance or law enforcement.
Not all employers will run a screening. And employers can’t surprise you with an employment screening. They have to ask for your written permission to run your report. Still, if you are applying for a job that requires you to manage money? You might find that the bankruptcy in your recent past could ruin your chances.
The bottom line? Bankruptcy might be the right choice for you. But don’t go into it thinking that your financial challenges will magically disappear. Filing will solve some problems, but it will also create others.
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