If you or someone you know is considering bankruptcy, it is important to understand what will happen as a result of the bankruptcy process.
When you file for bankruptcy, you will be affected in three important ways. First, you will end up with most, perhaps all, of your debts under control. This will give you the “fresh start” we talked about earlier. Second, your credit rating will be affected negatively, which can make your life more difficult. Finally, you may feel ashamed, or even guilty, which can cause you to suffer unnecessarily.
If you ever find yourself in this position, it is important to appreciate just how much pressure can be relieved by filing for bankruptcy. If you are like most people, accumulating too much debt was a long process that happened over months or even years. During this time, you were gradually accommodating to a situation that was getting worse and worse.
Filing for bankruptcy can bring instant relief because your debts are put on hold and your creditors must stop asking you for money. Indeed, the moment you file for bankruptcy, collection agencies must stop calling you; creditors are forbidden to collect a judgment against you; your wages cannot be garnished (withheld); and, if your house is in foreclosure, the process is stopped immediately.
After your bankruptcy is approved, you probably won’t have much money. Still, for the first time in a long time, your finances will be under control and, if you can keep yourself from feeling guilty (see below), the relief will be enormous.
The second effect caused by bankruptcy is that your credit rating will be affected negatively. The effects, of course, are serious, but they are temporary.
With Chapter 13 (reorganization), your bankruptcy will appear on your credit reports for seven years from the filing date (not the discharge date). With Chapter 7 (liquidation), the record will be kept for ten years from the filing date.
In addition, your credit reports will note which debts were part of the bankruptcy; they will be designated “included in bankruptcy.” All such debts will stay on your credit reports for seven years from the time the debt first became delinquent. (This is because seven years is the general cutoff period for all negative items on a credit report.)
At first, you will probably find it difficult to get any type of credit. However, the situation will get easier as time goes by, especially if you work to improve your credit worthiness. Nevertheless, you may have trouble being approved for a credit card, and it is unlikely you will be able to qualify for a mortgage for five to seven years.
Moreover, once you do get credit, it will be more expensive. For example, when the time comes that you are able to qualify for a mortgage, you may be required to pay a higher interest rate and higher fees; with a credit card, you will be charged a significantly higher interest rate. (Of course, when you use a credit card, the interest rate is irrelevant if you pay your bills in full every month, as you should be doing.)
On the other hand, when it comes to employment the law protects you against discriminatory treatment. When you apply for a job an employer is allowed to check your credit. However, they cannot refuse to hire you simply because you have gone bankrupt. Similarly, your current employer cannot fire you because you file for bankruptcy. (If you want to check the exact law for yourself, the reference is U.S. Code, Title 11, Chapter 5, Subchapter II, Section 525[b], “Protection against discriminatory treatment”.)
The third way in which filing for bankruptcy will affect you is emotionally. Most likely, you will experience the conflicting feelings of relief and guilt. Relief because the worst of the financial pressures will be gone from your life. Guilt because you may think that bankruptcy is shameful, and you now have a stigma that will never go away.
Some of the guilt is, no doubt, cultural. If you are American, you live in a country that sends strong social messages that everyone should always be able to take care of themselves and, if they can’t, it’s their own fault. In spite of the fact that life is often difficult, capricious, and unfair, it is astonishing how many people actually accept this mistaken belief, which leads to a great deal of unnecessary shame and suffering.
Much of the guilt you may be feeling comes from the distorted thinking that arises from the anxiety and depression caused by long-standing, hopeless financial problems. This is because it is common for people with serious problems to internalize the idea that there is something wrong with them and that their position is shameful. The truth is that, most of the time, the severe financial problems that force people into bankruptcy are not the fault of the debtor.
To convince you of this, consider the following list which shows the most common reasons people in the United States file for bankruptcy:
— Medical expenses
— Job loss
— Poor use of credit: credit cards, unaffordable mortgages
— Divorce or separation
— Uninsured expenses: theft, accidents, natural disasters
To be sure, in some cases, you may have had some influence over your misfortunes. Nevertheless, my guess is that, if you chose to file for bankruptcy, it is most likely because of circumstances beyond your control. It is also my guess that you agreed to file reluctantly, only after a long period of effort and sacrifice during which you valiantly tried to pay back your debts. If this is the case, I urge you to recall the two main ideas we discussed earlier:
Bankruptcy is an important part of our economic system, and is good for society as a whole.
It is morally desirable to use bankruptcy to give a fresh start to individuals who are overwhelmed with debt.
The stress of long-term, unmanageable debt is not only oppressive, it injurious to your health. For this reason, if it makes sense for you to file for bankruptcy and you don’t, you will end up hurting yourself and your family. Of course you want to consider carefully before taking such a big step. But having said that, it can be a big mistake to wait too long. If you struggle with too much for too long you are, effectively, sentencing yourself to live in the economic equivalent of a debtors’ prison – and –we learned a long ago that debtors’ prisons do not work.
All economic systems can be harsh, impersonal, unfair, and arbitrary at times. Consider the following.
Medical expenses: Many people in the United States do not have adequate health insurance.
Job loss: A long and deep recession harms millions of people indiscriminately.
Poor use of credit: Exploitive credit card and mortgage practices damage a great many individuals.
Divorce or separation: The breakdown of a marriage often creates unavoidable financial problems.
Uninsured expenses: Thefts, accidents, and natural disasters are, by their nature, unpredictable.
Once you accept these home truths, it is easy and reasonable to have sympathy for the many people each year who are forced by circumstances well beyond their control to file for bankruptcy. If you yourself ever decide to file for bankruptcy, please realize that there are huge forces that you cannot control that can affect and harm you. Once you realize this, you will see that you are in the same situation as millions of other people.
As such, you may want to extend to yourself the same compassion and understanding that you would, I am sure, offer to a friend or loved one who is experiencing hard times.
Author’s Note: “Understanding Bankruptcy” is a series of seven columns to help you understand our modern bankruptcy system and how it works. I suggest that you start with the first column and read them in order, if you have not already done so. As a reference aid, I have created a comprehensive glossary of bankruptcy-related terms. You can find it in the “Money and Economics” section of my website, harley.com.