Bankruptcy Alternatives

Federal and state laws provide bankruptcy as a remedy for unmanageable debt, but the price you pay to clear away financial obligations is a steep one.

Filing for bankruptcy will reduce your credit score by 100 points or more and make it much harder to borrow money or possibly even land a job.

The economic fallout from the COVID-19 pandemic looked like it was going to cause a flood of bankruptcy filings in 2020, but just the opposite occurred. Filings dropped from 774,940 cases in 2019 to only 544,463 in 2020, a 29.7% decline. That was the lowest since 1986.

Still, half a million filings represent a lot of financial pain and hardship and the pain could grow. Bankruptcy filings tend to escalate gradually after an economic downturn. Following the Great Recession of 2008, bankruptcy filings increased for the next two years, peaking in 2010 at 1.5 million.

Yet big debt doesn’t have to mean financial surrender. There are options other than bankruptcy if you’re buried under a mountain of debt.

In many cases it’s possible to work with a nonprofit credit counselor and devise a plan that rolls back debt gradually and avoids the dire financial and emotional consequences of bankruptcy.

A certified credit counselor should be able to evaluate your situation and recommend a course of action. Bankruptcy might be the only option, but in some cases, the better advice might be negotiating a debt settlement or enrolling in a debt consolidation plan that will allow you to avoid the courtroom and do less damage to your credit score.

Debt Settlement

Whether you use a debt settlement company or do it yourself, you can sometimes strike an agreement with creditors to pay less, sometimes considerably less, than what you owe. Debt settlement involves forgiveness. Creditors or a debt collector must be willing to accept partial payment for settling the full balance.

For debt settlement to work, you must be in default. Creditors won’t want to forgive any debt if you are making minimum monthly payments. If you’re in default and file for bankruptcy, creditors face not getting anything, so they might be willing to strike a deal. Only seek settlement of debts that you stopped paying but continue making minimum monthly payments on those you can afford.

Before you consider proposing a debt settlement, think about the impact it will have on your future credit. If creditors agree to write down what you owe them, the unpaid balance is considered income and must be reported on your tax return. The amount you don’t repay will be reported to the nation’s three large credit rating agencies and be part of your credit report for seven years. That could seriously degrade your credit score, an important metric used to assess your worthiness as a borrower.

Be careful dealing with for-profit debt settlement companies. Many have spotty track records. Don’t work with any company that wants you to pay a fee before it negotiates a deal with your creditors. By law, debt settlement companies can’t collect a fee until they’re reached a settlement and you’ve made at least one payment to the creditor. If you have multiple creditors, they can charge a fee for each one they are able to reach a settlement with.

The advantage to settling is speed. If you can put aside at least 50% of what you owe, you might be able to pay off creditors in 2-3 years. That is the time frame usually associated with debt settlement. It also will stop harassing calls from collection agencies and help you steer clear of bankruptcy court.

If you do it yourself, contacting creditors and explaining your financial bind, you also could save money on the fees a company would charge.

Debt Consolidation

Another alternative to bankruptcy is debt consolidation. To do this yourself, you need access to a credit line or a loan that will allow you to pay off your debts. That could be a personal loan from a bank or credit union, though more likely a home equity loan or credit line that allows you to borrow against your house.

It’s possible – though extremely unlikely if you’re thinking about bankruptcy – to get a 0% balance transfer credit card to help consolidate your debts.

You should meet with a nonprofit credit counselor or a financial advisor for advice before you consolidate. With a consolidated payment, you can often save on interest and avoid the headache of paying multiple bills each month.

If you qualify for a credit card that offers to temporarily lower your interest rate on balances, you could transfer debt to that card and use the grace period to pay down principal. Before moving ahead, make sure your other cards allow you to transfer balances without penalties.

A personal loan has advantages if it allows you more time to make fixed payments at lower interest than your credit cards were charging. Home equity loans and credit lines usually charge far less interest than credit cards, but you must offer your home as collateral. If you can’t make the required monthly payments, you could lose your house. Many financial advisors caution against moving unsecured consumer debt to a secured home loan for that reason.

Finally, you can use a nonprofit credit counseling agency to consolidate your debts through a debt management program.  If you go this route, the agency will collect a single monthly payment from you and oversee the payment of creditors. These programs usually take 3-5 years to eliminate the debt.

Sell Assets

If your income isn’t enough to make debt payments, consider selling your assets. Hold a garage sale or find a buyer for that coin collection you inherited from Uncle Lester. Obviously, the more valuable your assets, the more cash you’ll raise for debt payments.

If you file for Chapter 7 bankruptcy, there’s a good chance you’ll be required to sell many of your assets. If you have valuable assets, you might be able to reduce debts enough not to file bankruptcy. You could direct the money you realize through asset sales to an account you can use to settle debts.

If you have a business, selling assets might help avoid a bankruptcy filing. Of course, you need to come up with a strategy first – you’ll need to keep assets that are essential to operating the business.

Credit Counseling

If negotiating with creditors doesn’t work, consider contacting a nonprofit credit counseling firm like InCharge Debt Solutions. Credit counselors can help you decide between debt consolidation or bankruptcy and often develop a debt-management plan with payments you can afford.

If the credit counselor is able to work with creditors to lower your payments and interest rates, it could avert a bankruptcy filing. Even if you decide to file bankruptcy, the law requires that you consult a credit counselor first. Federal bankruptcy courts maintain lists of nonprofit counselors and you should consider contacting one before filing.

Borrow Money from Friends or Family

You may have friends or family who have stable finances and are willing to lend you money. This should be the last option before bankruptcy, because it’s loaded with pitfalls, the biggest one being that if you fail to repay the loan on time, it could end the relationship with a family member or friend.

If you go this route, treat it like a loan from a bank. Sit down and figure out what you owe, what you make and what you need to avoid bankruptcy. This will determine how much to money to ask for from your friend or family member.

Put it in writing, agree to a payback schedule and stick to it. While it’s hard to have financial problems, destroying a good relationship over it can be much worse.

Find a Way to Earn Extra Income

Finding a second job, or other ways to make money, may help you generate enough income to avoid bankruptcy. Just like borrowing from family and friends, look at this as an option to avoid bankruptcy, not as a way to make more spending money.

There are many ways to make extra money, particularly with the digital app-based world we live in. Jobs driving for Uber or Lyft, shopping or driving for Instacart, and other delivery and shopping services can be found almost anywhere, even in more rural areas. Keep in mind that most of these jobs require a smartphone, a car and a clean driving record.

There are multiple websites that list freelance and part-time jobs – just search “freelance jobs” and you’re off to the races.

Don’t, however, discount old-school methods. Your local newspaper or that free weekly that you normally throw away, lists local jobs, particularly things like babysitting, pet-sitting or walking and, yes, delivering newspapers. It’s also a good place to advertise if you want to do those things but don’t want to be beholden to an app. It’ll cost money to take out the ad, but not as much as you may think.

Whatever you do, be sure you have the time and energy to do it and target whatever money you make to paying down your debt and avoiding bankruptcy.

Restructure or Refinance Your Mortgage

If you own a house and are still paying your mortgage, that’s likely a big bill. If restructuring your mortgage to pay less will help you avoid bankruptcy, you should approach your lender and see if they are willing to help structure a new payment plan. They may also agree to a temporary repayment plan, until you can repair your finances.

You may also look into refinancing your mortgage, which means applying for a new one with a lower interest rate and a longer pay period. This option usually requires a good credit record, since a bank is giving you a new loan.

Lower Expenses Making Changes to Your Budget and Lifestyle

Lowering your expenses and making changes to your budget and lifestyle to save money that can be applied to your bills isn’t just an option to avoid bankruptcy, but also a good idea no matter what you decide to do to repair your finances.

It may seem overwhelming to create a budget, but it’s really a matter of figuring how much money you have coming in, how much you have going out and how to make income exceed expenses. It should be standard operating procedure, no matter what your financial situation is.

One of the easiest things you can do that will create more money in your budget to help pay your necessary bills is to lower your expenses. This can be big picture things like selling your house, getting a paying roommate or smaller things like canceling some of your streaming subscriptions.

Go through your bank accounts for the month and look at what you spend on things you don’t really need, including eating out, cable TV, gym memberships and other things you don’t need or may have even forgotten you were paying for. Also look at insurance, utilities, and other monthly costs and find ways to pay less.

Any money you spend should go to pay down your debt to avoid filing for bankruptcy.

What to Expect If You Can’t Avoid Bankruptcy

If after considering all the alternatives to filing bankruptcy, your only option is to file, be prepared. Know the consequences and what’s involved.

Filing for bankruptcy will cost you a significant amount of money. Retaining a bankruptcy attorney could cost you several thousand dollars. If you prepare and file your own bankruptcy case, the filing fees alone are substantial, and your chances of success are greatly reduced because it can be a complicated process with a lot of moving parts.

According to the National Bankruptcy Forum, the average cost of a Chapter 7 bankruptcy is $1,250.

You will be required to take a pre-filing bankruptcy course before you file, so that you are aware of the alternatives.

The good news is that if you file Chapter 7 bankruptcy, you have a good chance of success. Chapter 7 filings are discharged at around a 95% rate every year. Of those filing Chapter 13, 44% of debts were discharged, but that’s not necessarily a bad thing. In the cases where they weren’t, the judge believed the filer could handle their debts with the assets they had.

Officially, there are six types of bankruptcies – Chapters 7, 9, 11, 12, 13 and 15 – but 99% of bankruptcy cases filed are Chapter 7 (liquidation) or Chapter 13 (personal reorganization).

The other four, Chapter 11 (business reorganization), Chapter 9 (municipalities); Chapter 12 (farmers) and Chapter 15 (cross border) make up the other 1%.