When (and When Not) to File Bankruptcy

This article aids practitioners and others working with clients in determining when a client should or should not file bankruptcy, including the top seven reasons to file and seven reasons not to file bankruptcy.  Just as important is knowing the best time to start planning for and filing a bankruptcy, and knowing the cost of filing bankruptcy—it is not free.

Even when bankruptcy is their best option, clients have concerns that prevent them from filing. This article details six surprising bankruptcy facts that should dispel much of this reluctance, with a focus on chapter 7 bankruptcy.  Also listed are sources to find a bankruptcy attorney and additional bankruptcy resources. 

Top Seven Reasons to File Bankruptcy

—#1:  A Bankruptcy Filing Stops in Their Tracks Foreclosures, Evictions, Repossessions, Utility Shut-Offs, Garnishments, and Other Creditor Actions 

A bankruptcy filing will automatically and immediately, without any further legal proceedings, stop most creditor actions against a consumer and the consumer’s property—at least temporarily. A bankruptcy triggers an “automatic stay,” which stops the continuation of or the start of repossessions, garnishments, attachments, utility shut-offs, foreclosures, evictions, and debt collection harassment. The automatic stay provides time to sort things out and address the consumer’s financial problems. A creditor needs bankruptcy court permission to take any action against the consumer. Some creditors seek such permission immediately; others never seek permission.  See NCLC’s Consumer Bankruptcy Law and Practice Ch. 9. 

Permission to continue collection activity is rarely granted to unsecured creditors. Secured creditors can get “relief from the stay” in a chapter 7 bankruptcy case to continue foreclosure or repossession of their collateral. But an automatic stay will almost always continue to be in effect to protect the consumer in a chapter 13 bankruptcy case if the consumer is making payments on the secured debt.

If the creditor violates the automatic stay, the creditor may have to pay damages and attorney fees, and the creditor’s actions can be reversed. For example, a foreclosure sale that is held in violation of the automatic stay can be set aside. See NCLC’s Consumer Bankruptcy Law and Practice § 9.6.

—#2:  Bankruptcy Discharges Most Debts 

When a bankruptcy is successfully completed, many of the consumer’s unsecured debts, such as medical bills and credit card obligations are discharged.  While a chapter 7 bankruptcy discharge usually cannot eliminate a lien on collateral for a secured debt, it eliminates the debt itself and any deficiency owed after a foreclosure or repossession.

Certain debts may not be discharged, such as most taxes, alimony, child support, and debts incurred after the bankruptcy case was started. Federal student loans can be discharged only if repayment will be an undue hardship on the consumer’s family. Certain private student loans can be discharged in bankruptcy. See NCLC’s Consumer Bankruptcy Law and Practice Ch. 15. 

—#3:  Bankruptcy Offers Protection Against Wage Garnishment, Bank Seizures, and Enforcement of Judgment Liens

After a bankruptcy filing, creditors are prohibited from garnishing wages or other income or a bank account. Bankruptcy even stops government agencies from recovering Social Security or other public benefit overpayments, if receipt of the overpayment was not based on fraud. See NCLC’s Consumer Bankruptcy Law and Practice § 9.4.

Bankruptcy is also an effective tool for dealing with some types of court judgments. If a court judgment for money does not create a lien against the consumer’s property, that judgment debt can be discharged in bankruptcy. If the judgment does create a lien on property, the consumer can file a motion to remove the lien if it affects “exempt property,” and then the creditor can never touch that property. See NCLC’s Consumer Bankruptcy Law and Practice § 10.4.2. 

—#4:  Bankruptcy Prevents Seizure of Household Goods 

Most families’ household goods are exempt from seizure, and the consumer can keep them even in bankruptcy, even when a creditor has taken household goods as security for a loan, if that loan was not used to purchase those goods. See NCLC’s Consumer Bankruptcy Law and Practice § 10.4.2.4.

—#5:  Bankruptcy Offers Flexible Solutions for Auto Loans and Home Mortgages

Bankruptcy provides added flexibility in dealing with creditors who take property as collateral for their loans, such as car and mortgage loans, even though the consumer must still make payments on these loans if they want to keep the collateral. 

A chapter 7 bankruptcy lets the consumer keep a car by paying the creditor the lesser of what is owed on the loan or the car’s current value. If a car is worth $1,000, and the remaining amount on a car loan is $3,000, the consumer can keep the car by paying the creditor only the $1,000. The $1,000 payment usually must be made in a lump sum before the chapter 7 bankruptcy ends (usually after 3 to 5 months). Some creditors allow for that amount to be paid in installments over several months even after the bankruptcy ends, but that is up to the creditor. This right of redemption applies to any collateral that is personal property.  See NCLC’s Consumer Bankruptcy Law and Practice § 11.5.

A chapter 13 bankruptcy allows for greater flexibility to keep property. For example, if a consumer is 6 months delinquent on a mortgage, filing a chapter 13 bankruptcy stops a threatened foreclosure and allows the consumer to catch up gradually on back-payments—over as many as 3 to 5 years. In some cases, a chapter 13 filing also allows for lowering monthly payments by extending the repayment period or lowering the loan’s interest rate. But the consumer must keep making payments until the loan is paid off. For certain car loans that were not recently purchased, the consumer may be able to pay off a loan balance reduced to the car’s current value over the life of a chapter 13 plan. For all car loans, the debtor may be able to pay the loan at a lower interest rate. See NCLC’s Consumer Bankruptcy Law and Practice § 11.6.2.

—# 6:  A Bankruptcy Can Stop Utility Terminations and Even Restore Terminated Service

A bankruptcy filing stops any threatened utility terminations and restores terminated service, at least for 20 days. To keep utility service beyond 20 days after the bankruptcy filing, a security deposit (usually equal to approximately twice the average monthly bill) must be paid and the consumer must keep current on new post-bankruptcy utility charges but need not pay the past-due charges incurred before the bankruptcy was filed. Often the consumer can take 60 days to pay the deposit and some utilities may not require a deposit. See NCLC’s Consumer Bankruptcy Law and Practice § 9.8.

—#7:  Bankruptcy Prevents Driver License Revocation for Debt Non-Payment and Can Restore Suspended Licenses

If a driver’s license was or will be taken away because of an unpaid court judgment—such as one arising from an automobile accident—bankruptcy normally can discharge the obligation to pay the court judgment, and the consumer then has a right to regain or retain the driver’s license. In a chapter 13 case, the consumer may be able to regain or stop a license suspension because of unpaid tickets for parking or traffic violations. See NCLC’s Consumer Bankruptcy Law and Practice § 15.5.5.1.

Top Seven Reasons for a Client Not to File Bankruptcy

In many cases, bankruptcy may not be the right solution:

1. If all a consumer’s assets and income are exempt, the consumer is “collection-proof,” which means most creditors can do virtually nothing to harm the consumer even if the consumer does not file bankruptcy. Waiting until the consumer is no longer collection-proof is generally more prudent than filing right away, unless there is a concern with a home mortgage, car loan, or other secured loan. In the meantime, a letter from the consumer or the consumer’s attorney, particularly if it invokes the cease communication right under the Fair Debt Collection Practices Act, may be just as effective in stopping debt collection harassment. See NCLC’s Consumer Bankruptcy Law and Practice Ch. 6.
2. If the long-term expense of keeping a home or car exceeds long-term income, or if a consumer does not have sufficient income to keep up with payments while also catching up on past-due amounts on home mortgages, car loans or other secured loans. Bankruptcy can eliminate certain rights of secured creditors, and the bankruptcy filer can force secured creditors to take payments over time in the bankruptcy process, but consumers generally cannot keep the collateral unless they continue to pay the debt.
3. If a consumer has valuable assets that are not exempt in the bankruptcy process, and the consumer does not want to lose these assets. A chapter 13 filing may still help if the consumer can afford the necessary payments under the bankruptcy plan, which would require that unsecured creditors be paid at least as much as they would have received if the nonexempt assets were liquidated in a chapter 7 case. See NCLC’s Consumer Bankruptcy Law and Practice § 12.3.2. 
4. If the main reason for filing bankruptcy is to discharge a student loan, alimony or child support obligations, court restitution orders, criminal fines, or some taxes. These obligations are difficult, if not impossible, to discharge in bankruptcy. Some student loans though are dischargeable in bankruptcy; there is a program to assist consumers and the Department of Education to reach a settlement of bankruptcy discharge cases See NCLC’s Consumer Bankruptcy Law and Practice § 15.4. 
5. If the reason is to protect co-signers on a consumer’s debts. When a relative or friend has co-signed a loan and the consumer discharges the loan in bankruptcy, the co-signer may still have an obligation to repay all or part of the loan.  However, in a chapter 13 case a co-signer is protected from collection actions when the debt is being paid in the consumer’s plan. 
6. If a consumer only has a few debts and strong defenses for most of them.  Instead of filing for bankruptcy, the consumer can raise these defenses aggressively. Usually, the disputes can be settled out of court in an acceptable way. If they are not settled, the consumer can use bankruptcy later.
7. If a consumer has a prior bankruptcy, the consumer cannot receive a discharge in a new chapter 7 bankruptcy for 8 years after the prior chapter 7 bankruptcy. However, in most cases, a chapter 13 petition can still be filed. See NCLC’s Consumer Bankruptcy Law and Practice § 3.2.1.3.  

The Best Time to File for Bankruptcy

While it sometimes is too early to file bankruptcy, it is never too early to determine if bankruptcy is a client’s best choice in order to be ready to file a bankruptcy, especially when a client owns a home or vehicle or where court judgments are or will soon be outstanding. Filing bankruptcy is too late after a foreclosure sale or seizure of a bank account. Bankruptcy can stop a pending eviction proceeding, but there are fewer rights in bankruptcy after a court has ordered the eviction.

While advanced planning is best, there are options if a client seeks help at the last minute before a foreclosure, repossession, or garnishment. Bankruptcies in an emergency can be filed with little preparation by completing a brief petition, a statement of the Social Security number, and a list of the names and addresses of the client’s creditors. Additional forms must be completed shortly thereafter. The emergency bankruptcy still requires an approved budget and credit counseling briefing before the case is filed, usually taking less than an hour and completed over the phone or online. See NCLC’s Consumer Bankruptcy Law and Practice § 3.2.2. 

If clients are not facing immediate loss of property but will incur new unaffordable debts in the future, a bankruptcy filing should be delayed until those new debts are incurred. New debts incurred after the bankruptcy filing are not discharged in that bankruptcy case. For example, if a consumer is incurring substantial medical debts and does not have adequate insurance, it is better to wait to file until after the medical condition has been resolved or the debtor has sufficient health insurance.  Bankruptcy rules require that a second chapter 7 bankruptcy to discharge any new debts would have to wait eight years. 

If a consumer has sued someone for a significant sum of money or has a right to start a lawsuit, the consumer’s rights to recover that money after filing a bankruptcy may be turned over to the bankruptcy trustee and paid in at least part to creditors. Better to wait to file bankruptcy until after the money is received, if the consumer is still in need of bankruptcy relief. 

Before filing bankruptcy, clients should not go on expensive vacations or credit card shopping sprees that they do not intend to repay. In a chapter 7 bankruptcy, debts incurred in this way may be declared as nondischargeable. On the other hand, other pre-bankruptcy expenses for medical care and other essentials are rarely challenged. Clients should delay those payments and purchase in installments any needed medical or automobile insurance before filing bankruptcy.

The Cost of Filing Bankruptcy

It is expensive to file for bankruptcy. If you refer a client to a bankruptcy attorney, the attorney is likely to provide a free consultation to help the client decide whether bankruptcy is the right choice. If the attorney takes the case, the attorney will expect to be paid, unless they work for a nonprofit legal services office or are doing the bankruptcy on a pro bono basis.

Clients must pay a bankruptcy filing fee—$313 for chapter 13 or $338 for chapter 7. The fee can be paid in four installments over 120 days (or 180 days with court permission). The client can also ask the court to waive the filing fee in a chapter 7 case if household income is less than 150% of the federal poverty guidelines (for 2024, $30,660 for a family of two or $46,800 for a family of four). No waiver is allowed in a chapter 13 case.

In a chapter 13 case, the client pays their debts over time, and usually must pay the trustee handling the payments a 10% commission on each payment. While this can add up, the client may be paying far lower interest on their debts in a chapter 13 plan than if they had not filed bankruptcy. Even more significant, in a chapter 13 plan, they may only have to repay a small percentage of what they owe on most of their unsecured debts.

Six Surprising Facts Countering Client Reluctance to File for Bankruptcy

Even when bankruptcy is the right option, many consumers are reluctant to file based on misconceptions of the bankruptcy process.  Here are six surprising facts about bankruptcy that may allay some of those fears

# 1:  Bankruptcy Filers Typically Lose Little or None of Their Property 

The belief that a bankruptcy filing results in the loss of most of a client’s property is incorrect. Everyone who files for bankruptcy gets to keep some of their possessions, and most people get to keep all of them.

No matter the type of bankruptcy filed, unless property is collateral for a loan, a consumer gets to keep all property that is protected by state or federal exemption laws. Exemption laws typically protect clothes, appliances, furniture, jewelry, and often the family car and home. See NCLC’s Consumer Bankruptcy Law and Practice § 10.2.

Exemption laws often protect property that is worth less than an amount specified by statute. What that property is worth is based not on how much the property cost, but rather on the amount that the property is worth in its present condition minus the amount owed on secured loans and liens on the property.

For example, consider an exemption law protecting only a $2,000 motor vehicle, and a consumer’s car is presently worth $7,000 with a $5,000 car loan balance. The consumer has $2,000 in equity in the car and thus the car is fully protected by the $2,000 exemption. In the above example, the $5,000 car loan balance may still need to be paid if the consumer wants to keep the car because the auto lender has a secured loan, but the car is fully protected against other creditors.

What property and the amount of that property that is exempt varies widely from state to state and the application of exemptions in bankruptcy can be complex, particularly if the client has moved within the last two years to a different state or bought a home within the last 40 months. For a state-by-state summary of state exemption statutes, see NCLC’s Consumer Bankruptcy Law and Practice Appx. J.  For more about federal and state exemptions, see NCLC’s Consumer Bankruptcy Law and Practice Ch. 10.  The general rule of thumb is that, for most consumers filing bankruptcy, much of their property is exempt.

What property a client is able to keep also depends on the type of bankruptcy filed—a chapter 7 or a chapter 13. In a chapter 7 case, a consumer keeps their exempt possessions, but other property may be sold, with the money distributed to pay creditors. In a chapter 13 case, a consumer can keep property that is not fully exempt by paying the amount that is not exempt over time from future income under a plan approved by the bankruptcy court. If a consumer has very valuable property, it might be sold in a chapter 7 bankruptcy but kept if the non-exempt amount is paid to creditors over a number of years in a chapter 13 plan.

#2:  A Bankruptcy Filing May Actually Improve a Consumer’s Creditworthiness

Most often, clients should not worry about bankruptcy making it harder for them to obtain credit. If they are delinquent on several debts, this already appears on their credit record. A bankruptcy is unlikely to make their credit rating any worse; instead, it may make it easier to obtain future credit. See NCLC’s Consumer Bankruptcy Law and Practice Ch. 3.

New creditors will see that old obligations have been discharged in the bankruptcy and that the consumer has fewer other creditors competing with them for payment. Creditors also recognize that consumers cannot receive a second chapter 7 bankruptcy discharge for another 8 years. After bankruptcy, a consumer’s credit file will also list the outstanding balance as zero dollars for each of their debts discharged in bankruptcy.

Their credit file will list the fact that the consumer filed bankruptcy and that certain debts at one time were delinquent, but creditors are most interested in what a consumer owes now on each debt. The fact that a credit report shows that nothing is owed on a debt improves a consumer’s credit standing.

After a bankruptcy is complete, check the consumer’s credit report to make sure all the debts discharged in bankruptcy are listed as now owing zero dollars. File a dispute with the credit reporting agencies if discharged debts continue to be listed as having a balance owed.

Bankruptcy often helps to enhance the stability of a consumer’s employment and income. Wage garnishments, continuous collection calls, car repossessions, telephone disconnections, and other consequences of an unaffordable debt burden are eliminated, and this should help the consumer find and hold steady employment. Steady income is key to creditworthiness.

A bankruptcy will make it more difficult for a consumer to obtain a new conventional mortgage to purchase a home. Even then, most lenders will not hold the bankruptcy against the consumer if the consumer re-establishes a good credit reputation for 2 to 4 years after a bankruptcy.

After bankruptcy, some new lenders may demand collateral as security, ask for a co-signer, or want to know why bankruptcy was filed. Other creditors, such as some local retailers, may not even check the credit report.

Bankruptcies stay on a credit record for 10 years from the bankruptcy filing, while other debts are usually only reported for 7 years from their delinquency. If delinquencies on a consumer’s debts are 5 or 6 years old, bankruptcy will not help a credit record. Those debts will be deleted from a credit report within a year or two, while the bankruptcy will stay on record for ten years.

#3:  The Bankruptcy Debtor Typically Need Not Go to Court

Unless something out of the ordinary occurs, bankruptcy filers do not even go to court. They must attend one meeting with the bankruptcy trustee (not with a judge), and those meetings are now held virtually. Creditors are invited to that meeting but rarely attend. In the rare case that a consumer does receive a notice to go to court, it is important that they go and first receive advice from a bankruptcy attorney. Before a case is closed, the consumer must also take a course in personal finances, which will last for approximately two hours. The course can be taken online. In a chapter 13 case the consumer may have to attend a court hearing on confirmation of the plan. 

#4:  Bankruptcy Has Minimal Impact on Reputation in the Community

Most people find their reputations do not suffer from filing bankruptcy. Bankruptcies are not generally announced publicly, although they are a matter of public record. It is unlikely that friends and neighbors will know about a bankruptcy unless the consumer tells them.

However, especially in a small town, where debts are owed to local people, reputational issues connected with filing bankruptcy may arise. In such a situation, weigh possible embarrassment and damage to reputation against bankruptcy’s potential advantages. One option is to voluntarily pay selected debts after bankruptcy, but a debtor cannot leave selected creditors out of the bankruptcy process entirely.

# 5:  Feelings of Moral Obligation Should Not Prevent Choosing the Best Option for the Family

Most people want to pay their debts and make every effort to do so if payment is possible. If bankruptcy is the right solution, the consumer should balance these feelings of obligation with the importance of protecting the family.

Bankruptcy is a legal right. The United States Constitution includes a provision concerning bankruptcy. Big corporations like Kmart, American Airlines, Chrysler, and Macy’s—and famous people such as Toni Braxton, Tammy Wynette, Larry King, Mickey Rooney, Henry Ford, and Walt Disney—have all chosen to file bankruptcy. Even the Bible provides for debt forgiveness:

At the end of every seven years thou shalt make a release. And this is the manner of the release: every creditor shall release that which he has lent unto his neighbor and his brother; because the Lord’s release hath been proclaimed. (Deut. 15:1–2.)

Most important, during hard times, bankruptcy may be the only way for a consumer to provide their family with food, clothing, and shelter. It may be that bankruptcy is the best or only realistic alternative.

# 6:  Potential Discrimination After Bankruptcy

Federal bankruptcy law protects bankruptcy filers from being discriminated against because they have filed for bankruptcy. Government agencies, such as housing authorities and licensing departments, cannot deny benefits because of a previous bankruptcy, including debts discharged in bankruptcy that were owed to those agencies. Government agencies and private entities involved in student loan programs also cannot discriminate based upon a bankruptcy filing. See NCLC’s Consumer Bankruptcy Law and Practice § 15.5.5.

Employers are not permitted to discriminate against consumers for filing bankruptcy. However, for some sensitive jobs which involve money or security, bankruptcy may be considered evidence of financial problems that could be detrimental to work. Bankruptcy law does not prevent discrimination by others, including private creditors, in deciding whether to grant new loans. See NCLC’s Consumer Bankruptcy Law and Practice § 15.5.5.

Referrals to a Bankruptcy Attorney

To find a consumer bankruptcy attorney in your area for client referrals, you can use the “Find an Attorney” search on the National Association of Consumer Bankruptcy Attorneys’ website at www.nacba.org. Other possible options are local legal services offices (see at www.lawhelp.org/find-help) and a local bar association's pro bono panel.  Note that bankruptcy attorneys may be a good source of referrals when their clients need consumer attorneys for debt collection and other consumer law cases.

Additional Resources

This article draws heavily from NCLC’s Surviving Debt Ch. 25.  That chapter and all of Surviving Debt is free to the public in a digital format at  https://library.nclc.org/book/surviving-debt. (Print books can be purchased for $20 and bulk discounts apply.) 

Surviving Debt Ch. 26 explains how the bankruptcy process works in general terms.  Other Surviving Debt chapters cover debt collection, credit reporting, repossessions, utility terminations, student loans, foreclosures, tax debt, criminal justice debt, credit cards, collection lawsuits and post-judgment remedies, evictions, and much more.

NCLC’s Consumer Bankruptcy Law and Practice is a two-volume legal treatise covering all aspects of consumer bankruptcies, with filled-in and annotated official forms, 150 sample pleadings, and other resources. 

NCLC’s Bankruptcy Basics is a step-by-step guide for pro bono attorneys, general practitioners, and legal services offices new to bankruptcy. 

All three books are available at www.nclc.org/bookstore.