Filing for Bankruptcy Vs. Paying Old Collections and Charge-Offs

By Beverly Bird

If you're struggling to dig out from under a mountain of debt, you've probably considered your various options many times over. Whether it's better to file for bankruptcy or whittle away at your old debts with payments over time depends on your personal concerns and circumstances.

If you're struggling to dig out from under a mountain of debt, you've probably considered your various options many times over. Whether it's better to file for bankruptcy or whittle away at your old debts with payments over time depends on your personal concerns and circumstances.

The Automatic Stay

The automatic stay is one of bankruptcy's greatest advantages. It's something like an impenetrable wall that protects you from your creditors. You move behind the wall the moment you file a bankruptcy petition. Your creditors can't reach you there. They can't file lawsuits against you to collect what you owe, and they can't call you and ask when they might expect your next payment. They can't use judgments they've gotten against you in the past to garnish your wages or bank accounts, taking money you might have earmarked for something else.

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A Chapter 13 Plan

Chapter 13 is the bankruptcy plan that involves paying your debts off with your excess income each month after you've met your reasonable and necessary living expenses. You give this money to the trustee, and he in turn apportions it among your creditors. Chapter 13 plans run three to five years. During this time, you can pay off all your old debts just as you might have done without filing for bankruptcy, but you're protected by the automatic stay while you do so. The Chapter 13 trustee pays your debts in an order of priority, and unsecured creditors are last in line. At the end of your bankruptcy plan, these low-priority creditors may not receive all of what you owe them, but that's OK -- the balance is discharged anyway and you're relieved of responsibility for paying the remainder of those debts, even if they've long since gone to collection agencies.

Risks of Chapter 7

If your income exceeds your reasonable living expenses by $166 a month or more, you can't file for Chapter 7 bankruptcy. If you earn between $100 and $166 a month more than your necessary living expenses, the court will decide which chapter you may file. If you don't earn at least $100 more a month than you need to pay your regular bills, you're typically limited to filing for Chapter 7. You'll have the advantage of the automatic stay, but you run the risk of losing some of your assets. The trustee is authorized to take your non-exempt property and sell or liquidate it to pay off as much of what you owe as possible. Exemptions allow you to keep a certain dollar value in various items, such as your automobile. If an asset is not worth more than the exemption, the trustee won't sell it. If you think you have a lot of non-exempt assets, speak with an attorney to find out if paying off your debts on your own might be the better choice.

Effect on Credit

Another big bankruptcy issue is the damage it does to your credit score and report. A Chapter 7 filing stays on your report for 10 years; a Chapter 13 remains for seven. Filing either form of bankruptcy will pull your score down, but if you have a lot of charge-offs or debts with collection agencies, your score is probably already rather low. The question becomes how quickly you can build it back up again. If you file for Chapter 7, you can take out a secured credit card immediately after discharge, which is usually only a few months after you file. Your credit score can begin improving if you pay the account regularly, even though the bankruptcy still appears on your credit report. If you file for Chapter 13, your credit should – theoretically – start improving right away. By law, your creditors must stop reporting your accounts as past due as soon as the court confirms your repayment plan. In reality, creditors often neglect to do this, but you can check your credit report and bring the problem to their attention if they don't.

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What Are the Benefits of Filing Chapter 7?


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How Does an Automatic Stay Get Started in Bankruptcy?

When you file for bankruptcy, the court puts an injunction in place known as an automatic stay. You don't have to do anything – it happens automatically. The stay prohibits creditors from attempting to collect debts from you while your bankruptcy process is underway, and it gives you some breathing room while you sort out your financial affairs.

Chapter 13 Bankruptcy Procedures

Compared to Chapter 7, Chapter 13 is the kinder bankruptcy. You don't lose your assets; the trustee doesn't seize them and sell them to pay off your creditors, as he does when you file for Chapter 7. Instead, you fund a repayment plan with your extra income each month, which is what you have left over after paying your necessary living expenses. Chapter 13 requires that you have a regular source of income to provide for this, but you can generally save your home, automobiles and other property that acts as collateral for loans.

What Happens to the Cosigner if the Signer Goes Bankrupt?

When someone cosigns a loan for you, they are promising to repay the money if you don’t. A lender will require you to have a cosigner if it believes you are a high risk borrower or may default on the loan. Going bankrupt may relieve you of your obligation to repay the loan; however, your cosigner may be on the hook for the entire balance owed.

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