Does Filing Bankruptcy Improve Your Financial Situation?

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If you've recently fallen far behind on bills and are considering filing for bankruptcy, you may assume that getting out from under your debt will automatically place you in a more favorable financial situation. However, a recent study has shown that the aftermath of some 2005 changes to the federal bankruptcy laws may not always be rosy for consumers. Read on to learn more about some of the risks you may undertake when filing a Chapter 7 or Chapter 13 bankruptcy, as well as what you can do to protect yourself while filing for bankruptcy.

What are the financial consequences to filing a Chapter 7 or Chapter 13 bankruptcy?

Although the aftereffects of a bankruptcy are fairly similar whether you file a Chapter 7 discharge or a Chapter 13 repayment plan, the timeline can vary widely. For a Chapter 7 bankruptcy, your credit score will take a hit as soon as your petition is granted by the bankruptcy court. For a Chapter 13 bankruptcy, your credit score may remain low for the duration of your repayment plan, but will then begin to rise when your repayment plan is completed and your case is dismissed.

Another potential side effect of your bankruptcy filing can be a rise in your auto and homeowner's insurance rates. Insurance companies can often view customers with financial difficulties at a higher risk for filing claims than those who are in good financial shape.

Finally, if you file a Chapter 7 bankruptcy but have more assets than you're permitted to retain under the exemption rules, the bankruptcy court may be able to seize and sell your vehicle, jewelry, furniture, or other valuable and tangible possessions. If you find yourself in this situation but want to read more and retain your possessions, you may be better served by filing a Chapter 13 bankruptcy instead.

What can you do to minimize the negative effects on your finances after bankruptcy?

For a Chapter 7 bankruptcy there are several things you can do to prevent your credit score from dropping too far, as well as to recover your good credit more quickly.

First, fail fast. Although you may be reluctant to file for bankruptcy protection, filing quickly (rather than after you've already accrued a credit report full of late payments or defaults) can often be the best choice. Filing for bankruptcy will generally cause your credit score to drop by up to 240 points. However, the longer you wait to file, the more late payments and other negative entries are added to your credit score -- so the additional ding of a bankruptcy can cause your credit score to fall below 500, rather than the average mid-500 range.

Next, work on rebuilding credit as soon as your case has been finalized. Although the bankruptcy will drop off your credit report in less than a decade, taking with it its effect on your credit score, unless you actively work to rebuild this credit you may find that your score hasn't risen much by the time your bankruptcy is no longer reported. By taking out a secured credit card or other loan and making timely payments, you can ensure that your score will begin to rise.

If you're in a Chapter 13 bankruptcy, unfortunately there is not much you can do to increase your credit score during your repayment period (other than making the timely payments required under your bankruptcy plan). However, you may still be able to minimize the increase in your insurance costs by shopping around. In some cases, your current insurance company may be able to match a quote offered by a competitor, helping you avoid the hassle of changing policyholders.

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3 March 2015