What is Bankruptcy? Debunking 3 Common Myths

Bankruptcy is often held up as the worst thing that can happen to us financially. We are taught to fear it. Creditors have an incentive to make us scared of bankruptcy because it’s the only way to legally wipe away our debts (and their potential profits). Unfortunately, this fear-mongering keeps us trapped in debt and prevents us from building the kind of financial life we want.

What is Bankruptcy?

Bankruptcy is a legal process that enables businesses or individuals who can’t pay their debts either eliminate or create a payment plan over time. The bankruptcy process is meant to provide a path to financial recovery.

What are common myths about filing for bankruptcy?

Myth # 1: I’ll lose my home or car if I file for bankruptcy

In most cases, people who file for bankruptcy are able to keep their home and vehicle. Certain property is exempt from counting as an asset during bankruptcy, at least up to a certain value. The exemption limits vary from state to state (and which state you have to file in depends on where you live and how long you’ve lived there). In a Chapter 7 bankruptcy, as long as the equity in your home or the value of your car doesn’t exceed the exemption limit, you can keep it!

If you’re having difficulty making your mortgage or car payments because of your other debt, going through bankruptcy can actually put you in a better financial position to keep your home or car. Once that consumer or medical debt is cleared, you’ll have more room in your budget to afford them.

If the value of your property does exceed the exemption limits and you want to keep them, Chapter 13 bankruptcy may be a better path. In Chapter 13 bankruptcy, rather than wiping away your debts, you agree to repay them through a court-structure plan over 3-5 years. In this case, you still benefit from the exemption but you must pay the amount that exceeds the exemption to your creditors.

Myth #2: Bankruptcy will ruin my credit

By the time you consider bankruptcy, you often already have—or are on the verge of—late payments, delinquency, or default. All of this already negatively impacts your credit score. If you don’t have the resources (i.e. income) to regularly cover your debt payments and your spending needs, you’ll find it difficult to improve your credit score. Wiping away those debts gives you room in your budget to start building positive credit. The worse your credit is when you apply for bankruptcy, the more likely you are to actually see an increase in your score after you’re granted bankruptcy.

Alternatives to bankruptcy, such as debt settlement often have a more negative impact on your credit. This is because the debt settlement company will instruct you to stop paying your creditors and pay them instead while they settle your debts. Depending on how many debts you have and the total balance, it can take years to settle. Although bankruptcy will remain on your credit report for 7-10 years depending on which type you filed, you get the opportunity to start rebuilding your credit quickly.

Myth #3: I will never be financially successful if I file for bankruptcy

This is the biggest myth of them all! Wiping away debts that you can’t afford gives you the ability to reach financial success much faster because you’ll have more money in your budget to save for the future and afford your necessary expenses. If you are worried that you’ll never be able to reach a big financial milestone like owning your own home, no fear: you’ll be able to apply for a mortgage to buy a home within 2-4 years, depending on the type of loan. 

After bankruptcy, your financial success will be much more dependent on building a strong financial foundation and changing any habits or circumstances that led to the debt in the first place. 

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