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Are There Alternatives to Bankruptcy?

Understanding debt relief alternatives to bankruptcy

Bankruptcy law aims to give individuals with debt problems a fresh start, putting them on the path to being debt free.  

“Bankruptcy is a legal mechanism to address your debts,” says Alabama bankruptcy attorney Ronald Sykstus.  

“The bottom line is that bankruptcy [gives] a great deal of protection so that you don’t lose everything you’ve got,” says Sykstus. 

However, filing for bankruptcy isn’t the only way to address debt and isn’t the best option in many cases.  

“Every situation is different,” says Skystus. “The income is different; the expenses are different.”  

Because of this, it’s essential to carefully consider your financial situation and weigh alternative courses of action before filing for bankruptcy. 

This article will cover some of the alternatives to bankruptcy and when declaring bankruptcy makes sense. Once you’re familiar with the options, consider speaking with a bankruptcy attorney about your situation.  

What Is the Purpose of Bankruptcy? 

The purpose of bankruptcy law is to give individuals with debt a legal, court-administered process for addressing and eliminating those debts.  

Bankruptcy is an alternative to “doing nothing and getting collected on,” says Sykstus.  

If “debt collectors are writing, calling, or suing you, or maybe you’re in danger of being behind on your house or car payments, or you’re going to lose those items… bankruptcy comes in with this big umbrella of protection called the automatic stay,” he says. 

“Once a bankruptcy is filed—the moment it’s filed—you have this protection called the automatic stay, which stops every creditor from suing you.”  

While there are ways for creditors to get around an automatic stay and still collect, they must go through the bankruptcy court to do so. This gives the debtor a degree of protection and peace of mind. 

The most common bankruptcy options for individuals are: 

  • Chapter 7 bankruptcy 
  • Chapter 13 bankruptcy 

Chapter 7 is sometimes called “liquidation bankruptcy” since it involves selling (liquidating) your assets to pay off debts.  

By contrast, Chapter 13 involves creating a payment plan based on your income to pay off debts over several years (typically 3-5 years). 

Various factors go into choosing between chapter 7 and chapter 13.  

For example, you may be at risk of losing some property through liquidation that you would be able to keep under chapter 13. However, you may not qualify for chapter 13’s repayment requirements. 

There is also a means test for chapter 7.  In this test, says Sykstus, the “bankruptcy code looks at what your income is relative to your family expenses. If you’re over a certain threshold, you per se cannot do a chapter 7 bankruptcy.”  

To figure out which type of bankruptcy would be best for you, speak with a bankruptcy attorney in your area about your financial situation. 

Options Before Filing Bankruptcy 

“Overlaying bankruptcy is your credit report,” says Sykstus. “What does your credit look like? That’s the starting point—get your credit reports… and know your debts.”  

If, for example, “you’re current on your house and your car, and have maybe one or two medical-related debts, reach out to those people,” he says.  

When reaching out to creditors, “I always recommend doing so in writing—ideally, [all communications] should be through certified mail with return receipts, just so you have a tracking that you’ve tried.” 

Sykstus also recommends “[keeping] a big box to collect all your collection letters, so you have everything in one central place.” 

Once you have a sense of your debts and credit, you can “kind of decide the best option from there,” he says.  

“If your credit report looks great and you maybe have one debt, then I don’t really think bankruptcy is the correct option. However, if you’ve got seven collection letters, a lawsuit, and you’re behind on your car or your house, then it makes a lot more sense.” 

Before getting to the bankruptcy stage, consider the following options: 

  • Create a budget. This may seem obvious, but if you haven’t created a budget to keep track of expenses, consider doing so as soon as possible. With a budget in place, you may be able to pinpoint unnecessary costs and save money that can be put toward paying down your debts. 
  • Debt negotiation with creditors. Try contacting your creditors directly to negotiate a repayment plan. They may be open to a monthly payment plan that eliminates your debt without further legal action.  
  • Get help with a debt management plan. For help with a debt management plan that avoids bankruptcy, you have a couple of options:  
    • Credit counseling agency. A credit counseling agency will help you assess your credit report, budget, and create a debt management program for paying off debts.  
    • Debt settlement company. Whereas credit counseling agencies advise you on your financial situation, debt settlement companies act as intermediaries with your creditors to arrange debt settlement.  

Whether you go through a nonprofit credit counseling agency or a debt settlement company, it’s important to realize that there are disadvantages to debt management plans. For example, if you miss a payment, any of your creditors can back out of the plan.  

  • Consolidate debt. Debt consolidation means you bring all your debts under a single payment to one creditor instead of having multiple payments to different creditors. There are various methods for consolidating debt, including getting a debt consolidation loan and transferring credit card debt to a lower interest rate credit card. 
  • Refinancing your mortgage. Getting your mortgage at a lower interest rate can help you save money on your house payments. 
  • Take no action. Sometimes, the best course of action may be to do nothing. Suppose you don’t anticipate your financial situation improving, and you don’t have any assets that creditors could collect. In that case, you are considered “judgment proof.” If a creditor tried to sue you, they wouldn’t be able to get any money or property from you. Under the federal Fair Debt Collection Practices Act, debt collectors cannot harass you for payment. 

Whether you pursue one of these alternatives or decide to file bankruptcy, Sykstus says, “a lot of thought should go into the timing of filing bankruptcy to make sure all debts will be discharged.” 

“For example, say you’re on unemployment and don’t have health insurance. You file a chapter 7 bankruptcy today to get rid of all your current debts. But tomorrow, you break your leg and have a $20,000 medical bill. That bill is not dischargeable because it happened after you filed bankruptcy.”  

More generally, if you anticipate expenses in the near future, it may make sense to wait on filing bankruptcy so all debts can be discharged.  

“A lot of exploration needs to go into it and when,” concludes Sykstus. 

Questions for a Bankruptcy Attorney 

If you’re thinking about bankruptcy, “do your research,” says Sykstus. “Know what your debts are and who you owe.” 

“Knowledge is power. At least, it will make you feel a little more in control to kind of get started on what your approaches can be,” he says.  

Once you understand your financial situation, consider speaking with a bankruptcy attorney.  

An experienced attorney will be well-versed in bankruptcy law and your state’s exemptions. They will be able to talk you through your options with sound legal advice.   

Fortunately, many bankruptcy attorneys provide free consultations, allowing the attorney to hear the facts of your case and for you to determine if the attorney meets your needs. 

To see whether an attorney or law firm is a good fit, ask informed questions such as: 

  • What are your attorneys’ fees? 
  • What billing options do you offer? 
  • What type of bankruptcy might I qualify for? 
  • Does bankruptcy make sense, given my financial situation? 
  • Are there good alternatives to eliminate my debt? 
  • When should I file for bankruptcy? 
  • What exemptions do I have under my state’s law? 

For help with your bankruptcy questions, look for a bankruptcy lawyer in the Super Lawyers directory.

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