Bankruptcy v. Doing Nothing

Should you file for bankruptcy to get rid of debts, or can you sit back and wait?

Updated by , Attorney

If you're struggling with debt, filing for bankruptcy can be a good way to get your finances back on track. But not everyone needs to start a bankruptcy case right away. Whether you should file for bankruptcy or do nothing will depend on whether you're vulnerable to creditors. In some cases, doing nothing (at least for now) might be the best option.

Do You Have Anything Creditors Can Take?

Most creditors need to file and win a money judgment in court before they can take your property. If, however, you don't have anything that a judgment creditor can collect, you're "judgment proof." You won't need to file for bankruptcy.

Generally, you're judgment-proof if:

  • You don't have any equity in real estate.
  • You don't own any assets that you can't protect from creditors. (State exemption statutes prevent you from giving up certain types of property to collection or bankruptcy, such as equity in a home or car, food, or basic living necessities.)
  • You aren't working or have a very low-paying job.
  • You receive an income source that's exempt from creditors, such as Social Security benefits (and, in some states, unemployment other public entitlement benefits).

But, being judgment proof can be a temporary situation. For instance, being out of a job now but employable in the future isn't the same as being permanently retired.

If you are relatively sure your financial situation won't improve substantially, and if collection pressure doesn't bother you, there might not be a reason to file for bankruptcy.

If you have assets and your creditor sues you, you can learn what will happen in Creditor Lawsuits: What to Expect When the Case Is in Court.

Will Bankruptcy Wipe Out Your Debt?

Not all debts get discharged in bankruptcy. If you'll still have to pay your most worrisome bills after filing for bankruptcy, then filing probably won't be good idea. On the other hand, if filing for bankruptcy gets rid of enough debt that you'll have more money to devote to nondischargeable debt, bankruptcy might still help.

Below are some debts that are either difficult or impossible to wipe out in bankruptcy. Also, creditors with these types of debt can use collection techniques like wage garnishments or bank levies even without a judgment.

Past Due Child Support

A Chapter 7 bankruptcy filing won't eliminate or reduce child support debt. So filing for Chapter 7 bankruptcy won't help unless you can free up future income you can use to pay your child support by discharging other debt.

A Chapter 13 bankruptcy case, however, can be a better option. You can stop collection actions by entering into a three- to five-year repayment plan to pay off your past-due support payments in full. Be aware that if you have a hefty outstanding balance, your monthly payment might be steep because you must pay off all of the arrearages in the plan. You'll still have to continue making your ongoing child support payment, as well.

If you can catch up in Chapter 13 bankruptcy, here are some of the complications you'll avoid:

  • wage garnishment
  • loss of unemployment compensation
  • jail time
  • offsets of federal or state income tax refunds
  • passport denial
  • offsets of state lottery winnings
  • driver's license suspension
  • reduction of workers compensation benefits, or
  • reduction of social security or disability benefits.

Find out more by reading What Are the Differences Between Chapter 7 and Chapter 13 Bankruptcy?

Past Due Income Taxes

Taxpayers with outstanding tax debts are subject to a levy on assets or other income sources. A levy is a legal seizure of your property to satisfy a debt. Once a levy is in place, it usually remains until you pay off your tax debt.

If you owe past-due income taxes and you do nothing, you could face the following:

  • losing state or federal tax refunds
  • a reduction in social security benefits
  • a wage garnishment (depending on the state in which you live), or
  • a lien against your real estate.

Understand that a bankruptcy filing won't eliminate recent tax debts. However, through a Chapter 13 case, you might be able to pay off the tax debt over a period of three to five years.

(To find out when you can discharge tax debts, see Tax Debts in Chapter 7 Bankruptcy.)

Student Loans

If you're in default on your student loans, the lender could result in a:

  • wage garnishment (depending on the state in which you live)
  • offset of federal and state income tax refunds
  • loss of eligibility for federal aid, including Pell grants
  • loss of deferment or forbearance options, or
  • reduction in Social Security income.

It's not easy to discharge student loan debt in bankruptcy. You must prove that paying your loans will cause an undue hardship, which is a tough standard to meet, although not impossible in every situation.

Are You at Risk of Losing Your Home or Car?

If bankruptcy can help you save your home or car, it might be a good choice for you.

If you're behind in your mortgage or car loan payments, you can catch up on those payments through Chapter 13 bankruptcy. You might also be able to get rid of second mortgages or home equity lines of credit or reduce your car loan to the market value of the car. (See Your Home and Mortgage in Chapter 13 Bankruptcy and Your Car in Chapter 13 Bankruptcy.)

In Chapter 7 bankruptcy, you can't bring a loan payment current, but if you can get rid of other debts to free up money to pay your mortgage or car loan, it might be worthwhile to file. Keep in mind that to keep a house or car in this chapter, you'll want to be current on your payment when you file. (See Your Home in Chapter 7 Bankruptcy and Chapter 7 Bankruptcy and Your Car.)

Alternatives to Bankruptcy and Doing Nothing

Before you decide on filing for bankruptcy or doing absolutely nothing, consider other options for dealing with debts by reading Alternatives to Bankruptcy.

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