Common types of bankruptcy and how to avoid filing

Bankruptcy is a legal process to help individuals and businesses manage overwhelming debt. While it provides a path to financial relief, the decision to file bankruptcy requires careful scrutiny due to its lasting impact on credit, assets and future financial opportunities.

The two most common types of bankruptcy for individuals are Chapter 7 and Chapter 13, each with its own eligibility criteria and debt repayment structure.

How bankruptcy works

Bankruptcy is governed by federal law and overseen by the U.S. bankruptcy courts.

When you file for bankruptcy, you formally declare your inability to pay outstanding debts. In return, you may be granted a fresh start financially. The process can temporarily stop collection activities, such as creditor calls, wage garnishments and foreclosures. However, some debts, like student loans, child support and certain taxes, are generally not dischargeable through bankruptcy.

Filing for bankruptcy involves its fair share of fees. These include court filing fees, attorney fees and the cost of required credit counseling and debtor education courses. For Chapter 7 bankruptcy, the court filing fee is $338, while Chapter 13 costs $313.

You do not need an attorney to file for bankruptcy, but hiring one can make it easier to navigate the process and is highly recommended if you are unfamiliar with bankruptcy law and procedures. Attorney fees vary depending on the case’s complexity but can range from $1,000 to $6,000 or more. Some courts may allow payment plans for court fees, and low-income filers may qualify for a fee waiver.

Common types of bankruptcy

The two most common types of bankruptcy are Chapter 7 and Chapter 13. They account for 67 percent and 32 percent of all non-business filings, respectively. Each type of bankruptcy serves a different purpose and has unique eligibility requirements, procedures and outcomes.

Chapter 7

Chapter 7 bankruptcy, often called “liquidation bankruptcy,” involves selling non-exempt assets to pay off creditors.

You may be allowed to keep some essential property, like a car if the value isn’t deemed excessive and personal belongings such as clothing, household goods or tools you need for work, but exemption laws vary from state to state. Once the available assets are sold, the proceeds go to creditors, and any remaining unsecured debt is typically discharged, meaning you are no longer responsible for paying it. The process usually takes a few months to complete.

Chapter 7 is ideal if you have limited income and few valuable assets, but it remains on your credit report for up to 10 years, affecting your ability to obtain new credit.

Chapter 13

Chapter 13, known as “reorganization bankruptcy,” lets you create a repayment plan to repay debts over three to five years. Unlike Chapter 7, this type of bankruptcy allows you to keep your assets while making monthly payments to creditors via a trustee. Once the repayment plan is completed, any remaining eligible debt may be discharged. This option stays on your credit report for up to seven years.

The primary difference between Chapter 7 and Chapter 13 bankruptcy is how debts are resolved. Chapter 7 provides a faster path to debt relief through asset liquidation and debt discharge, while Chapter 13 requires a longer repayment process but allows you to retain your property.

Why people file for bankruptcy

People file for bankruptcy when they face overwhelming debt that they can no longer manage through traditional means.

Life events like job loss, medical emergencies or divorce can cause a sudden or significant loss of income, making it hard to keep up with financial obligations. Without a steady income, you may fall behind on mortgage payments, car loans and credit card bills, leading to mounting debt. Over time, late fees, interest charges and collection actions can compound the problem, making it nearly impossible to recover without legal intervention. Bankruptcy provides a structured path to financial relief, allowing you to eliminate or restructure debt and stop aggressive collection efforts.

Medical debt is one of the most common reasons people file for bankruptcy. Unexpected medical expenses can quickly drain savings, especially without adequate health insurance. Even with insurance, high deductibles, copayments and out-of-network charges can leave you with many unpaid bills.

Credit card debt is another major contributor to bankruptcy filings. People often rely on credit cards to cover living expenses during financial hardship, but high interest rates and fees can cause balances to grow faster than they can be repaid. When these debts grow insurmountable, bankruptcy can offer a way to discharge or reorganize that debt, providing much-needed relief.

Another common reason people file for bankruptcy is to stop foreclosure, eviction or repossession of essential assets like a home or vehicle.

Filing for bankruptcy triggers an “automatic stay,” a legal order that temporarily halts these collection efforts. This pause allows you to explore repayment options or negotiate new terms with creditors. Chapter 13 bankruptcy, in particular, allows you to catch up on missed payments over time, potentially saving your home or car from being taken away. For many, bankruptcy serves as a last resort to regain control of their financial situation and protect their most important assets.

Pros and cons of bankruptcy

Filing for bankruptcy is a significant financial decision with benefits and drawbacks. While it can provide immediate relief from debt and a chance for a fresh start, it also carries long-term consequences that affect your credit, access to loans and personal finances.

Understanding the pros and cons of bankruptcy is essential for anyone considering this option. By gaining a clear picture of both sides, you can make a more informed decision about whether bankruptcy is the right path for you.

Pros of bankruptcy

• Asset protection: Chapter 13 bankruptcy allows you to keep essential assets like a home or car while you work to catch up on missed payments through a repayment plan.
• Debt discharge: In Chapter 7 bankruptcy, eligible debts such as credit card balances, medical bills and personal loans can be discharged, meaning you are no longer legally required to pay them.
• Financial education: Many filers are required to complete financial literacy courses, equipping them with the tools to make better financial decisions in the future.
• Immediate debt relief: Filing for bankruptcy triggers an automatic stay, halting creditor calls, wage garnishments, foreclosures and repossessions. This provides immediate relief from collection activities.
• Structured debt repayment: Chapter 13 bankruptcy creates a court-supervised repayment plan lasting three to five years, giving you a clear path to financial recovery.

Cons of bankruptcy

• Damage to credit score: Bankruptcy has a long-term impact on credit. Chapter 7 remains on your credit report for 10 years and Chapter 13 stays for 7 years, affecting access to future credit and loans for buying a house or new car.
• Debt exclusions: Some debts cannot be discharged through bankruptcy. If you owe student loans, child support, alimony and certain types of tax debt, you’ll still be responsible for these payments.
• Higher borrowing costs: After bankruptcy, obtaining loans or credit cards may be more difficult. When credit is available, it often comes with higher interest rates and stricter borrowing terms.
• Loss of assets: In Chapter 7 bankruptcy, non-exempt property (like vacation homes, second vehicles or valuable collectibles) may be sold to pay creditors.
• Time and cost: The bankruptcy process can be lengthy, requiring months or even years to complete. It also involves legal fees, court filing fees and the potential need to hire an attorney.

How to avoid filing for bankruptcy

Filing for bankruptcy should be a last resort, as it has lasting consequences on credit and financial opportunities. Fortunately, you can take proactive steps to avoid bankruptcy and regain control of your finances.

Budget

One of the most effective strategies is to create a detailed budget that tracks income, expenses and debt payments. Free up funds to pay down debt by identifying areas where spending can be reduced. Prioritizing high-interest debts, such as credit cards, can prevent balances from growing due to compounding interest, and setting up an emergency fund can prevent future financial crises from pushing you toward bankruptcy.

Negotiate

Another strategy to avoid bankruptcy is to negotiate with creditors. Many creditors are willing to work with borrowers to create a repayment plan or modify loan terms. Options like debt consolidation or refinancing can simplify payments and lower interest rates, making debt more manageable.

Credit counseling agencies can assist in negotiating with creditors, providing expert guidance on repayment strategies. These agencies can also help you enroll in debt management plans, which may allow for reduced monthly payments and waived fees.

Professional help

Seeking professional financial guidance can be a game changer when bankruptcy feels imminent.

Nonprofit credit counseling agencies and financial advisors offer advice on managing debt, cutting expenses and setting up payment plans. Financial counselors can review your financial situation and recommend alternatives to bankruptcy, such as debt settlement or debt consolidation loans. Additionally, legal consultation with a bankruptcy attorney can clarify your options, rights and potential consequences.

By taking early action, seeking professional help and exploring alternatives, you can avoid the lasting impact of bankruptcy and establish a path to long-term financial stability.

The bottom line

Bankruptcy is a legal option designed to provide financial relief to those facing overwhelming debt, but it comes with significant consequences that can impact credit, asset ownership and financial opportunities for years.

The most common types of bankruptcy for individuals are Chapter 7 and Chapter 13, each with unique eligibility requirements and outcomes. While Chapter 7 offers a fast track to debt discharge, it may require liquidating certain assets. Chapter 13 allows for a structured repayment plan over time, helping individuals retain valuable property like a home or car.

If you’re struggling with debt, filing for bankruptcy is not your only option. Taking early action can help you avoid bankruptcy altogether. Creating a budget, negotiating with creditors and working with credit counseling agencies are all viable alternatives that can lead to debt reduction and financial stability.

If bankruptcy still seems like the best course of action, consult with a bankruptcy attorney or financial advisor to fully understand your rights and responsibilities. Proper guidance can ensure you choose the best path to your financial future. No matter your situation, resources are available to help you regain control of your finances and move toward a debt-free lifestyle.