Why Declaring Bankruptcy Can Be Good, Actually

When Clara*, 32, realized her debt was getting out of control, she chose to do something that is both a valid recourse for people in her position and also a totally stigmatized one: She filed for bankruptcy. “I’d been feeling the effects of not being able to pay all of my monthly obligations — that happened for almost two years,” she recalls. “I had about 13 credit cards and a personal loan, and at the time my income was very low.” All together, the debt amounted to about $20,000. “I simply had to make a choice to be able to afford rent and everyday living costs over credit card payments.”

Clara declared what’s called Chapter 7 bankruptcy, which can erase most kinds of personal debt. “[My debt] was literally all credit cards from department stores, regular credit cards, personal loans, and a very small portion of medical debt,” she says, also sharing that, at the time, she was 29 and had no children. All of Clara's debts were the kind that are instantly discharged when filing Chapter 7; the hard part, Clara explains, was doing the research ahead of time, and figuring out what would happen to her credit after. Also, she says, “I just felt a little embarrassed.” 

But once she made the decision, it all went relatively smoothly. Clara hired a bankruptcy lawyer who helped her through the process. That cost around $1,500, but it also instantly alleviated burdens like the constant phone calls she'd been getting from debt collectors. The lawyer “combed through my credit reports and took all of my creditors/debt collectors' information in order to place a halt on collection efforts,” she says. Just three months later, Clara was debt-free.

“I was surprised at how quick and easy it was,” she says. Now, three years later, Clara explains, the bankruptcy “is no longer affecting me at all.”

Lisa*, 52, filed for Chapter 13 bankruptcy about a year after a divorce that she likens to “a bad Hallmark movie.”

“All the investments were in his name, and he cleared out the bank accounts the day he walked out,” she says. During her marriage, she admits her lifestyle was lavish. “I was a stay-at-home mom who drove a Mercedes and had a Chanel bag. When the divorce came, I was like every cautionary tale — there were times when I couldn’t afford milk.”

“When the divorce was final, I took my settlement and made a bad business investment and ended up over $100,000 in debt. It was incredibly stressful. I was dodging creditor phone calls, robbing Peter to pay Paul by either paying off one card just enough to get a cash advance to pay another, buying things on a store card and returning them for cash to pay off other debts,” says Lisa. “I am not proud of any of it, but my credit cards were maxed out from this investment, and I had to feed my child. I sold everything of value I owned — clothes, shoes, jewelry, the china and silver I got for my wedding.”

None of that was enough, because of course, interest kept piling on — with rates around 18 percent. It got to the point where all her payments were purely going toward interest. “My boyfriend at the time kept suggesting I file [for bankruptcy],” she says. “I kept saying no because I felt like I had too much pride.” She gained weight, developed an eye twitch, and started having trouble sleeping. “So when he suggested it for the fourth or fifth time, I decided to look into it.” She started looking round for a good bankruptcy attorney. “I remember dressing up for the appointment — how stupid to try to impress a lawyer while you’re there to declare bankruptcy.”

As part of Chapter 13 bankruptcy, she was put on a five-year plan, during which she would make more manageable monthly payments to creditors. If she makes all of these payments for five full years, any remaining debt will be cleared (with some exceptions based on what kind of debt it is).

“At the time I filed, I felt like an absolute failure,” says Lisa. “How did I get myself into a position where I couldn't pay off my debts? The decision to file also pissed some people off — my therapist took it as a personal betrayal that I wasn't going to be able to pay her for the year of therapy. I still feel awful about that. There are a lot of feelings I haven’t worked through about the whole thing.”

She remembers that being in court — and being scrutinized — was terrifying. “I looked around and the court room was full of people just like me, explaining that their restaurant failed or their business got cheated, and it made me realize that there are a lot of people in the same position,” she says.

Lisa is now a little over four years into her five-year plan, but the anxiety hasn’t gone away. “Every time I get a letter from the trustee of the bankruptcy, I worry if they’re going to take it back — which they can do if you don't pay each month on time or fail to turn in your tax returns. I freak out,” she says. “If I get a small tax refund, my attorney has to argue that I don't earn money over the summer so I need it to live. I feel like there’s an ax hanging over my head at all times.”

“I think people need to realize that people don't enter into bankruptcy lightly,” Lisa says. “There’s still a lot of shame about this, but people need to realize that sometimes it’s the only light at the end of a very dark tunnel. I also think there should be an easier system in place to rebuild credit, as opposed to exceptionally high interest rates or having to use your credit card like a debit card. I still don't have a credit card, and it’s a vicious cycle — can't build credit without a card, and can't get a card with a bankruptcy record.”

While there were consequences to filing, Lisa knows that doing so gave her a roadmap to a better future. “I’m no longer afraid to pick up the phone,” she says.

Women like Clara and Lisa are among the millions of Americans who’ve filed for bankruptcy in the last decade. In 2019 alone, 750,878 Americans declared personal bankruptcy. In 2008, in the aftermath of the subprime mortgage crisis, non-business bankruptcy filings exceeded 1 million and reached a high of 1.5 million in 2010.

In a recession, the expectation is that the number of bankruptcies goes up — fewer people have steady employment, and thus more people are struggling to pay their bills. In the recession that has accompanied the COVID-19 pandemic, when many are struggling to even afford food, experts predicted that personal bankruptcy filings would definitely rise. But a recent Harvard Business School working paper analyzed why they’ve in fact fallen drastically in the past year. While it’s likely for a mix of reasons, that overall personal bankruptcy filings have been declining for years is a symptom of how prohibitive the cost and difficulty of the process can be thanks in part to a 2005 bankruptcy bill that made it more difficult to declare bankruptcy.

Unfortunately, the fact that filing for personal bankruptcy isn’t easy to navigate, qualify for, or afford contributes to the fog of shame around it. People have come to believe that it’s what you do when you’re ready to admit defeat, instead of seeing it as a safety net that exists to shield you from defeat.

It’s time to change that. Declaring bankruptcy may not be the smartest choice for everyone, but there’s no reason it should be confusing or stigmatized. Ahead, we’ve broken down what you need to know about bankruptcy.

“I think you need to consider all your other options and figure out how feasible it is,” says Ashley F. Morgan, a bankruptcy attorney at Ashley F. Morgan Law. “If you’re current with your bills, but you feel like you're spinning your wheels, not making any progress, you may have some more options out there — consolidation, refinance, stuff like that. After you've defaulted and people are trying to sue you or sending you to collections, you tend to have less options at that point.”

But Morgan points out that there are people who do continue to keep current with their debt payments, yet they’re not really making progress, even after years of payments. Bankruptcy would wipe away most of this debt immediately or after a few years. If that’s the case, it might make financial sense to begin bankruptcy proceedings.

“Not really,” says Morgan. “If you have an 800 or 850 credit score, yeah, you’re going to see a 200-point drop. But a lot of people who are maxed out or have 90-day delinquencies on their credit actually may see an improvement. Most people, post-bankruptcy, after the dust settles, their credit’s around 600 to 650.”

The perception that filing for bankruptcy will devastate your credit score for good is a little overblown. While it probably will impact your credit, you’re not going to have to use cash for the rest of your life or be barred from buying a home for the rest of your life. Your bankruptcy will remain on your credit record for 10 years if you file for Chapter 7 bankruptcy, and for seven years if you file for Chapter 13.

Clara, who had mostly credit card debt, found her score actually went up after a few months. “It went down, but then it went up,” she says. “I was already in the low 500 range, and it didn’t go down a lot [after bankruptcy] — a couple points. But then a couple months after, it shot up by over a hundred points to, like, 650. And then from there it's just been going up for the last three years.”

She does admit that it was hard to get an unsecured credit card for a while. “I had to start with a secured credit card that had a $200 limit, then one year after the discharge I was approved for two unsecured credit cards,” she says. “It took a year because I didn't have an immediate need for credit, and I was trying to let time pass and not have any credit inquiries hit my report. In the same year that I received my two credit cards, I also was approved for an auto loan with no cosigner.”

If you suspect bankruptcy might be a good option for you, it’s probably smart to try a consultation with an attorney — many offer one for free. You can begin figuring out which kind of bankruptcy is appropriate for you: Chapter 7 or Chapter 13. 

Chapter 7 is often called a “liquidation” bankruptcy. That means that your assets can be taken away and go toward your unpaid debt. But after that, the remainder of your debt will be wiped — you don’t have any more payments to make. Chapter 7 filings are far more common than Chapter 13 filings.

Liquidation doesn’t mean you have to give up all of your belongings. Most Chapter 7 filers don’t actually get anything taken away, because there are exemptions based both on asset category and value thresholds (like getting to keep up to a certain amount of home equity). “Ninety-five percent of my clients don't lose anything, because the laws are fairly generous about what you can keep,” says Morgan. “But they’re very state specific.” You can look up what items or how much is exempt in your state here.

But you should also know that bankruptcy doesn’t erase all debts. Chapter 7 can wipe credit card balances, medical fees, personal loans, even unpaid rent. These are all known as unsecured debts. But with secured debt — debt that has collateral behind it, like a car or a house — you have to continue making payments, or the car or house can be taken from you.

“Figure out what your priorities are,” Morgan advises. “If your priority is protecting your house and the state you live in doesn't have an exemption or a law that protects your house, maybe [Chapter 7] isn't something you want to consider.”

You also have to qualify for Chapter 7 in order to file for it; so, if you have too much disposable income, it might not be possible. “The difference between a Chapter 7 and Chapter 13, for most people, is income,” Morgan says.

Chapter 13, on the other hand, is called a “reorganization” bankruptcy. Your debt isn’t immediately wiped, but arranged into a more feasible amount of monthly payments over a period of three to five years. Because you’re continuing to make payments to your creditors, your assets won’t be seized when you file bankruptcy. After your five-year plan has been completed, qualifying debt will be discharged. You still have to pay your mortgage if you want to keep your house, though, and child support, alimony, and student loans, among some other exceptions, won’t be erased.

That’s a good question without a satisfying answer. It’s not like it’s secured debt — no one’s snatching your diploma away if you default on your student loans. And it wasn’t always this way, either. Just decades ago, you could discharge student debt in bankruptcy just like you can your personal loans. But in 1976, Congress changed the law in fear that Americans were taking advantage of the federal student loan system — living a life of irresponsible excess by, uh, getting a college degree and then filing for bankruptcy if they couldn’t afford the exorbitant payments. It was an unfounded fear, too; less than 1 percent of federal student loans were being wiped by bankruptcy when Congress decided to act.

Still, it’s not impossible to discharge student debt. It could happen, the same way you could win the $1 billion Mega Millions jackpot. That said, recently, there have been a few cases in various states where people have managed to discharge hundreds of thousands of student debt.

The problem, says Morgan, is that a ruling to discharge your student debt could be reversed. “All of them have been appealed by the student loan companies,” she says. “So it’s really hard, and probably the only way we're going to get some change is if Congress changes [the law] or the Supreme Court starts interpreting it differently.”

You’d think that declaring bankruptcy, a thing you do when you’re in dire financial straits, would be free. Unfortunately, it can cost thousands of dollars. The fee to file Chapter 7 bankruptcy is currently $338. For Chapter 13, it’s $313. These fees can be waived if your household income is below 150 percent of the federal poverty level, and you can also try to pay it in installments. 

But if you hire a bankruptcy attorney, you’ll probably have to pay thousands in legal fees as well, especially if you live in an expensive area. Though people who file Chapter 7 usually earn a lower income than Chapter 13 filers, ironically it can be easier to afford Chapter 13 legal fees, since you’d be on a multi-year plan to make debt payments. Since the nature of Chapter 7 bankruptcy is to wipe all your debts once your filing has gone through, “the general rule has always been, if you owe your attorney any money when you file, you can't collect — because the moment you file, creditors can't collect,” Morgan says. Still, she points out that many attorneys do try to work out installments in some way, because they understand that their clients simply may not have the money. “I've seen some people borrow against their 401k [to pay bankruptcy fees], which I don't encourage by any stretch of the imagination,” says Morgan.

Yes, you can. You don’t have to hire a bankruptcy attorney — it’s just recommended that you do. “There are people who get by just fine with filing themselves,” says Morgan. “It's not the craziest thing, but the devil's in the details.” One mistake could make the difference between success and failure, and if you’re not a bankruptcy expert, you simply might not know what a mistake looks like until you’ve already filed. “People have had to hire me after they filed themselves, and it costs more for me to clean it up than for me to do it right the first time,” Morgan says.

If you have nothing to lose in terms of assets, though, and your case is extremely simple — or you simply don’t have the money — filing yourself is possible. There are tools to help you do so, including a non-profit called Upsolve that walks people through the process of filing for bankruptcy without legal representation. To date, the organization says it has helped discharge over $250 million of debt.

“To us, it's not just an access gap. The cost of bankruptcy is a civil rights injustice,” says Rohan Pavuluri, Upsolve’s CEO. “The legal fees are like a modern-day poll tax. When you can’t afford to pay, you can’t afford your rights.”

“Upsolve is generally a good fit for people who are low-income, can't afford a lawyer, don't own a home, and own less than $10,000 in assets,” he continues. “People who are higher income and have more assets often have more complicated cases. Since most attorneys provide free evaluations, it can be a good idea to just talk to a lawyer and educate yourself before deciding how to proceed.”

It’s not a decision to be made lightly, and there are serious structural problems in the way bankruptcy is handled in the U.S. — but shame should not be a reason you rule out bankruptcy when it could be the answer to your problems. Having to file for bankruptcy is not a reflection of your character, or how smart or responsible you are. It’s often a reflection of living in a society where merely existing is expensive.

Morgan says that the stigma around bankruptcy is something she fights every day, though she says it has been changing since 2007, when personal and business bankruptcies exploded. “A lot of people especially now feel a lot of remorse, but I don't think anyone saw COVID coming, and who could've predicted we’d be in the world we are now?” she says.

Pavuluri hopes that the law will change to reflect the need for bankruptcy filing to become cheaper and easier, and that more types of debt should be wiped. “We believe that low-income families should be able to discharge their student loans in bankruptcy,” he says. If people declare bankruptcy yet still have student debt, “the bankruptcy system isn't accomplishing its intended purpose of giving low-income families a fresh start.”

“Over 90 percent of bankruptcies are tied to medical issues, job loss, and divorce,” Pavuluri points out. “These are all shocks beyond our control, and when you're living paycheck to paycheck like millions of Americans, a sudden shock can ruin your life. Bankruptcy is a lifeline.”