Bankruptcy acts as a protection for individuals with too much debt. The process wipes away certain debt and allows the debtor to financially begin anew. Several dangers and pitfalls do exist, however. The bankruptcy process comes with negative consequences, not everyone may benefit from bankruptcy, and the bankruptcy process itself can become expensive.
Individuals facing extreme financial situations present a less-than-appealing target for creditors. Creditors rely on income and assets to satisfy any outstanding debt. An individual with little income (minimum wage or unemployed) and no assets has nothing for the creditors to take ownership of and liquidate. Consequently, debtors who own nothing and make little money may not stand to benefit from bankruptcy protection.
Chapter 7 bankruptcy requires debtors to liquidate assets to cover part of the debt incurred. Exemption laws protect some personal assets during the bankruptcy process, but these laws vary from state to state. Debtors with large amounts of non-exempt property run the risk of losing some or all of this type of property through the Chapter 7 liquidation process. Chapter 13 bankruptcy, on the other hand, allows the debtor to keep property and create a new affordable payment plan if the debtor has a steady income.
Debts that Avoid Bankruptcy
Some debts stay with you permanently after bankruptcy. These debts include student loan debt, alimony, child support, taxes, and personal injury claims. Since bankruptcy does not remove these debts, the process is pointless for those whose debts are primarily in these areas.
Bankruptcy lowers your credit score and stays on your record for 10 years for Chapter 7 bankruptcy and seven years for Chapter 13 bankruptcy. This makes it more difficult to obtain loans or credit cards, or to rent apartments. Even if you can obtain a loan, the bad credit results in higher interest rates.
Some debtors may find the bankruptcy process difficult and require assistance from an attorney. Hiring such help means paying high hourly rates or a large flat fee. These costs may prove difficult to pay, and the attorney can turn into another creditor if you fail to pay in a timely manner.
No Personal Liability
Individuals who own a failing small business may consider filing for personal bankruptcy if personally liable for any debts owed. On the other hand, businesses set up as a limited liability corporation (LLC) or another type of organization that protects owners from personal liability may not have to file for personal bankruptcy. In this situation, creditors liquidate the assets of the business and not the individuals since no personal liability exists.