What Is One Consequence of Going Into Bankruptcy?

Bankruptcy offers a legal pathway for individuals or businesses to manage overwhelming debt. It provides a structured process under federal law to address financial obligations when repayment becomes unsustainable. While it can offer a fresh financial start, filing for bankruptcy carries significant and immediate consequences that reshape a filer’s financial landscape.

Impact on Credit Report and Score

A bankruptcy filing profoundly affects an individual’s credit report and credit score. The bankruptcy entry becomes a public record and appears on a credit report for an extended period, signaling financial distress to potential lenders. A Chapter 7 bankruptcy typically remains on a credit report for 10 years from the filing date, while a Chapter 13 bankruptcy generally stays for seven years.

The immediate impact on a credit score is a sharp decline, often by 100 to 200 points or more. Individuals with higher pre-bankruptcy scores may experience a more significant drop. This negative mark indicates a heightened risk to creditors, making it challenging to obtain new credit. Despite the initial severe impact, the effect of bankruptcy on a credit score can lessen over time, even before it is removed from the report.

Debt Relief and Undischarged Debts

A primary consequence of bankruptcy is the discharge of certain debts, which provides debtors with a fresh financial start. This means the debtor is no longer personally obligated to repay these specific debts, and creditors are prohibited from further collection activities. Many types of unsecured debts are typically discharged in bankruptcy, including credit card debt, medical bills, personal loans, and some past-due utility bills. This discharge applies to most consumer debts.

However, not all debts are eligible for discharge through bankruptcy. Certain categories of debt are generally considered non-dischargeable. These commonly include most student loans, unless a debtor can prove an “undue hardship.” Most tax debts, especially recent income taxes and federal tax liens, are also typically not discharged.

Other debts that are not discharged include domestic support obligations such as child support and alimony. Debts incurred through fraud, embezzlement, or willful and malicious injury are also usually non-dischargeable. Additionally, certain government fines, penalties, and criminal restitution orders are generally not discharged.

Treatment of Assets

The treatment of a filer’s assets is a significant aspect of the bankruptcy process, varying based on the type of bankruptcy filed. In a Chapter 7 bankruptcy, known as liquidation, a court-appointed trustee reviews the debtor’s assets. The trustee identifies and sells “non-exempt” assets, with the proceeds distributed to creditors.

Exempt assets are those protected by law that the debtor is allowed to keep, such as equity in a primary residence, a vehicle, retirement accounts, and household goods. Non-exempt assets, which are not protected, might include a second home, luxury items, or significant cash savings beyond the exemption limits. While Chapter 7 aims for liquidation, many individual cases are “no asset” cases where all property is covered by exemptions.

Conversely, in a Chapter 13 bankruptcy, which involves reorganization, filers typically retain all their assets, including non-exempt property. Instead of asset liquidation, the debtor proposes a repayment plan to creditors over three to five years. The plan requires the debtor to pay an amount equal to or greater than the value of their non-exempt assets to unsecured creditors. This approach allows individuals with a regular income to protect their property while addressing their debts through structured payments.

Obtaining Future Credit and Services

After a bankruptcy filing, individuals face challenges when seeking new financial products and services. Lenders, landlords, and even some employers often view a bankruptcy on a person’s record as a significant risk indicator. This can result in higher interest rates, stricter terms, or larger down payments for loans like mortgages and car loans. Securing new credit cards can also be difficult, often requiring reliance on secured credit cards, where a cash deposit acts as collateral.

Renting an apartment or house can also become more challenging, as many landlords conduct credit checks. A bankruptcy filing may lead landlords to request higher security deposits or require a co-signer.

Regarding employment, federal law generally prohibits employers from discriminating against current employees solely due to a bankruptcy filing. However, for certain positions, particularly those involving financial trust or security clearances, employers may review credit reports as part of background checks. This could impact job prospects in specific industries. Despite these challenges, it is possible to rebuild credit and regain access to financial services over time through diligent financial management and consistent on-time payments.