How much debt is worth filing for bankruptcy?

Bankruptcy is one option for dealing with a big debt problem. Whether it’s a good idea depends on several factors. The amount of debt you hold is a key consideration, but it's only one part of a larger picture. The types of debt you have, your income, and what and how much you own all help shape the decision.

Struggling with debt can leave you feeling financially and mentally drained, but there are solutions for dealing with debt—at every level. Let’s explore how your debt levels and other factors could affect whether you decide to file for bankruptcy or not.  

When to consider bankruptcy

In a nutshell, bankruptcy may be an option to consider when it objectively makes the most financial sense. When you have a debt situation that requires some kind of intervention, there are only a few paths forward.

People tend to seek out bankruptcy, the legal process for dealing with debt, when debt is overwhelming. 

Bankruptcy is not a moral failing. It’s something people are sometimes told they need to feel ashamed of—but there's no shame in pulling yourself out of a financial hole.

At the end of the day, filing for bankruptcy is a financial decision. And sometimes, it’s a smart way to deal with debt. 

Cost of bankruptcy

Filing for bankruptcy isn't free; there are court fees. And if you're not comfortable filing on your own, you might hire a bankruptcy attorney to help you. People who hire attorneys tend to have more successful outcomes than bankruptcy filers who represent themselves.

You might pay anywhere from a few hundred to a few thousand dollars to file for bankruptcy. So you have to ask yourself whether your amount of debt justifies the expense. 

Types of debt you have

Bankruptcy won't get rid of certain kinds of debt. Debts that can't be discharged or erased in bankruptcy include:

• Tax debt, including property taxes

• Spousal and child support

• Debts relating to a personal injury claim against you

• Restitution for some crimes (money the court orders you to reimburse victims for their losses)

• Government fines and penalties (including restitution, tickets, tolls, and civil judgments)

• Some co-op and condo fees

• Debts owed to some tax-advantaged retirement plans

It’s possible to get rid of secured debts through bankruptcy. Secured debts are guaranteed by something valuable that the lender can take if you don’t fully repay the debt. Mortgages and car loans are two common examples. If your mortgage or car loan is wiped out in bankruptcy, you would lose the home or car. 

Student loans are a toss-up. It's possible to get student loan balances discharged (erased) in bankruptcy, but it may be difficult—you must prove that paying your loans would cause long-term financial hardship. 

The Departments of Justice and Education are working together to make the bankruptcy discharge process for student borrowers easier to navigate, but the initiative is still relatively new. If you have student loans and are wondering about your options, you may want to contact the Department of Education or your loan servicer to ask. 

The main thing to know here is that you won't be able to get rid of absolutely all kinds of debt with bankruptcy. 

Type of bankruptcy you qualify for

There are different types of bankruptcy. If you're filing bankruptcy as an individual, you're usually talking about Chapter 7 or Chapter 13. 

Chapter 7 wipes away your eligible debts. Eligible debts are generally unsecured, such as credit cards, personal loans, medical bills, payday loans, past-due rent, and past-due utility bills.

To qualify for Chapter 7, you have to pass a means test. It’s a calculation to determine whether you have the “means” (i.e., income) to pay something toward your debts. If you can afford a payment, you can’t file Chapter 7.

With a Chapter 13 bankruptcy, you'll have to apply all of your disposable income toward your debts for three years (if you’re low-income) or five years (if your income isn't low). Income levels are based on the county where you live. 

Once you complete your Chapter 13 plan, any remaining balances on your enrolled debts are discharged (forgiven). 

Whether it’s worth it to file for bankruptcy could ultimately depend on which type you qualify for. About half of Chapter 13 cases fail because the required payments tend to be very high. But you don't have to file Chapter 13 if you don't qualify for Chapter 7. There are bankruptcy alternatives that might be a better fit, even if you've got a lot of debt. 

Whether you have assets to protect

Filing Chapter 7 to get rid of debt sounds great, but there's a catch. If you own things worth money, you might have to turn some of them over to the bankruptcy court. The court will sell them and distribute the money to your creditors.

In a bankruptcy filing, assets you may have to surrender include:

• Homes or land

• Home equity

• Vehicles

• Household furnishings

• Jewelry

• Bank accounts

• Life insurance policies

• Some pensions

• Appliances

• Family heirlooms

• Tools

• Musical instruments

• Collectibles or artwork

The court doesn’t take the clothes off your back. You’re allowed to keep some of the things you own. They are called bankruptcy exemptions, and the list varies depending on where you live. In all states, there are limits on what you can keep. You might have to give some things up as a trade-off for having the court wipe out your debts. 

You don’t have to give up your assets when you file Chapter 13. 

Effect of bankruptcy

When you file bankruptcy, it shows up on your credit reports, and has a negative impact on your credit standing. 

How damaging is bankruptcy to your credit? It depends. If you're going into a bankruptcy filing with late payments or collection accounts on your credit history, your score might already be low. In that case, the damage could be less severe. If you have a good or excellent credit standing when you file, the drop can be steeper. 

You can bounce back from bankruptcy and recover your credit standing over time by practicing good credit habits: pay all of your bills on time and keep credit card balances low. You could see some improvement in the first 12 months or so after filing, but it may take several years to get your score back to pre-bankruptcy levels. 

Alternatives to bankruptcy

Bankruptcy isn't your only way to get rid of debt. Debt resolution is a possibility if you don’t qualify for Chapter 7 bankruptcy, or you decide bankruptcy isn’t worth the expense, or you don't want to have a bankruptcy on your credit report. 

Here's how debt resolution works:

• You negotiate with creditors to get them to accept less than what you owe.

• If the creditor agrees to the deal, you pay the agreed amount. 

• The creditor forgives the remaining debt balance. 

That's a simplified version, but the goal of debt resolution is to get rid of debt for less than what you owe. And you don't have to go through the courts to do it, or give up any assets. 

You can negotiate your own debts if you’re comfortable with learning the process and making the calls. Or you could work with a professional debt resolution company that will negotiate on your behalf.  

What’s next

Talk to a debt expert who can look at your income, budget, and debt, and offer real-world solutions that could help you move forward. Since there’s no minimum amount of debt for bankruptcy, whether it’s worth filing ultimately comes down to how much you might pay to file, whether you can get any of your debt discharged (forgiven), and how urgently you need a reprieve.