Should I file bankruptcy for $12K debt?

If you’re struggling with unmanageable debt of any amount, you may be considering filing for bankruptcy as a possible solution. But is it worth it for a debts under $10,000? While bankruptcy can bring some much-needed relief to those who are unable to repay their debts, it comes with serious negative consequences that make it inappropriate for low amounts of debt. 

How much debt justifies filing for bankruptcy?

There is no minimum amount of debt required to file for either Chapter 7 or Chapter 13 bankruptcy. However, many bankruptcy attorneys advise against filing for bankruptcy if you have less than $10,000 in dischargeable debt because the legal fees and filing costs could outweigh any potential benefits of filing.

“The average cost of filing can range anywhere from $1,000 to more than $5,000 depending on the state you file in and any associated attorney costs,” says Adam Selita, CEO of The Debt Relief Company.

Given the high fees, when does it make sense to file for bankruptcy?

As New Jersey bankruptcy attorney Edward Hanratty says, “I usually tell people that . . . if there’s a reasonable chance that they will be in the same position in six months, or worse off, then bankruptcy can be a great tool to solve the problem.”

What are the consequences of filing for bankruptcy?

Several negative outcomes associated with filing for bankruptcy can create financial difficulties for years. Among the most significant consequences is the impact on your credit profile.

Credit score drops

“Bankruptcy will cause your credit score to drop,” says Amy Maliga, financial educator for the nonprofit credit counseling company Take Charge America.

“Perhaps counterintuitively, the higher your credit score is when you file bankruptcy, the bigger hit you’ll take. On average, someone whose credit is very good or excellent at the time of filing will see their score drop from 200 to 240 points, while someone with only fair credit will notice their score drop anywhere from 130 to 150 points.”

Bankruptcy will stay on your credit report for at least seven years and, in some cases, could linger as long as 10 years. This will make it more difficult to borrow money for common purposes like buying a new vehicle, funding your education or purchasing a home. You may even need a co-signer or co-borrower to offer further assurance that the loan will be repaid. 

Even if you are approved for new loans or lines of credit, you’ll face high interest rates and less favorable payback terms.

Possible seizure of assets

With Chapter 7 bankruptcy, the courts may be able to seize some of your possessions to repay creditors. Maliga says these possessions can include vacation or rental properties, valuable art, stamp or coin collections, fine jewelry, designer clothing, antique furniture, certain investments and other items at the court’s discretion.

Financial harm to your existing co-signer(s)

When a co-signer guarantees a debt on your behalf, they become jointly responsible with you for paying off the debt. Your bankruptcy can impact their finances. 

“If any of the loans you discharge in bankruptcy has a co-signer, that person will now be responsible for repaying the outstanding loan balance,” says Maliga.

Is bankruptcy the right choice for you? 

Given the negative consequences of filing for bankruptcy, you may be wondering when bankruptcy makes sense. Filing for bankruptcy may be a good solution for borrowers who:

• Have more than $10,000 in dischargeable unsecured debts like credit card bills, medical expenses or personal loans.
• Have exhausted other debt-relief options and cannot feasibly pay off their existing debts.
• Deal with regular harassment from creditors and need legal protection.
• Wish to stop a home foreclosure or vehicle repossession in progress.   
• Want to stop wage garnishment and free up income to cover essential living expenses.

Can you get out of debt without bankruptcy?

For many borrowers, it is possible to get out of debt without bankruptcy. Because there are so many potential downsides associated with declaring bankruptcy, it’s wise to consider other alternatives first.

Debt consolidation

Debt consolidation typically involves obtaining a loan from a lender and using the proceeds to pay off all your debts. This approach leaves you with a single loan payment that should ideally be easier to manage.

When looking for a debt consolidation loan, make sure you’re getting a lower interest rate than what you currently pay on your debts. Also, consider the loan’s terms and fees to ensure the loan is a good deal and works for your financial situation.

If your credit is not strong enough to qualify for favorable terms on a debt consolidation loan, try finding a lender that allows you to apply with a co-signer. This could boost your chances of approval with a lower interest rate than what you’re paying on your current debts. 

You should also change your financial habits to succeed long term. “You’ll need to have the discipline to stop using credit cards; otherwise, you’ll end up making your loan payment as well as credit card payments,” says Maliga.

Strategic debt payment plans

By adding some strategy to your debt repayment, you can potentially pay off your debts faster and with lower total interest expense. 

With the debt snowball strategy, for example, you focus on paying off your smallest debt first and then apply the money you used toward that debt to attack the next-smallest debt. This builds momentum, or “snowballs” your debt repayment efforts.    

Here’s how the debt snowball method works:

• List all your debts from smallest balance to largest.
• Pay as much as you can toward your smallest balance while continuing to make minimum payments on your other debts.
• When your smallest balance is paid in full, apply the amount you had been paying on that debt to the next-smallest debt.
• Continue paying off each debt in this way until you are debt-free.

“The debt snowball method can be especially effective for someone who has several credit cards with relatively low balances and for those who need to see quick progress to stay motivated,” said Maliga.

The debt avalanche strategy works the same way, but it focuses on paying down the debt with the highest interest first and working down from there. 

“Overall, the avalanche method will get you out of debt quicker while saving more money,” says Sean Fox, president of Freedom Debt Relief. 

Paying off higher-interest debts first reduces your overall interest expense. As Fox explains, “If you pay more on the debt with the highest interest rate, you’ll reduce the amount you spend on interest every month.”

The downside to this approach is that it can take several months or even years to pay off your highest-interest debt. This can make borrowers feel like they aren’t making progress quickly enough, which can cause them to give up on this approach.

Budget reevaluation

To get out of debt without the negative consequences of bankruptcy or debt settlement, consider reworking your budget. By eliminating all unnecessary spending and putting every dollar you can toward paying down debt, you can get out of debt much sooner. 

“This means spending only on essentials, like housing and food, and putting wants — including leisure travel — on hold until you can get your debt under control and find yourself in a more stable financial situation,” says Maliga.

If you need help working out a budget, financial advisors or nonprofit credit counseling can be an effective tool. In addition to reviewing your income, expenses and debts and helping you plan a budget, trained credit counselors can offer additional solutions for paying off debt.

Debt relief services

“Debt relief” is a general term for any service that helps reduce debt, but it is commonly used to describe a more specific strategy, often referred to as debt settlement, debt resolution or debt negotiation. Debt relief companies work on your behalf to negotiate a debt repayment that’s less than what you currently owe.

For this solution, you’ll need to have enough debt to meet the company’s minimum (typically around $10,000 worth of unsecured debt). Resolving all your unsecured debt can take two to five years, depending on your situation.

Using a debt relief service will also severely impact your credit score. In most cases, the debt relief company will instruct you to stop making payments to your creditors (if you haven’t already). Instead, you’ll make payments to an account with your debt relief company, which they will use to offer lump-sum payments to the creditors. 

This strategy gives the company leverage when negotiating with the creditor. The more concerned they are that you will default completely, the more likely they are to accept a percentage of the balance due and forgive the rest. However, this approach may result in a growing history of missed payments. 

If you do decide to go this route, choose your debt relief company carefully. “A debt settlement company that has a long history, and a history of working with your creditors, means greater expertise,” says Fox.

Note that many experts consider debt settlement worse for your long-term credit score and financial health than bankruptcy. 

The bottom line

While no minimum amount of debt is required to file bankruptcy, the fees and financial ramifications make this an unappealing option for smaller debts. Bankruptcy is typically best reserved for borrowers with over $10,000 in dischargeable debt — and only after considering less invasive debt relief options.