When you are unemployed and have a lot of debt, your first impulse may be to file bankruptcy. While it may very well be your best choice, especially in terms of timing, consider some of these issues before rushing to file your petition.
If a creditor sues you and gets a judgment, it has the power to garnish your wages, attach your bank accounts and seize other property. A judgment creditor probably can't take everything you own, though. State law protects some -- or maybe even all -- of your assets. These protections are referred to as “exemptions.” For example, a portion of your cash in bank accounts, car equity, and furniture might be exempt -- which means a creditor can't take them if you object. How much you can “exempt” depends on the type of property you have and how much it's worth. Your state's laws will tell you how much and what type of property you can exempt (For more, read Using Exemptions to Protect Property From Judgment Creditors).
If a creditor gets a judgment against you, you should figure out if your assets are partially or fully exempt. A judgment creditor can only seize nonexempt property. If all of your property and wages are exempt, then the creditor can't take anything. For example, a creditor cannot garnish your unemployment earnings because they are exempt.
If you have significant nonexempt assets (such as home equity) and are faced with collection action by a creditor, your best bankruptcy option is Chapter 13. However, in Chapter 13 bankruptcy you must pay your creditors (in a three-to five-year repayment plan) an amount that is at least sufficient to cover the value of your nonexempt assets. If your unemployment benefits do not leave you with enough disposable income to make this possible, then Chapter 13 won't work for you.
For more information on how protecting assets in bankruptcy works, read Should I File for Chapter 7 or Chapter 13 If I Want to Keep My Home?
If you have been unemployed for a long period of time, and do not expect your situation to improve in the near future, then bankruptcy may be a good option if creditors can take some of your property. However, if you have nothing that the creditors can grab, then it might be best to do nothing. You are limited as to how many times you can file for bankruptcy within a certain time period, so you don't want to file for bankruptcy too soon if your debts will continue to mount. If you end up with more debt after bankruptcy, you'll be stuck with it for years. (To learn more, see Multiple Bankruptcy Filings: When Can You File Again?)
Even if you are uncollectible, have only been unemployed in the short-term, and owe a lot of debt, a Chapter 7 bankruptcy (assuming you are eligible) may be a good way to cleanse your credit report of a history of bad collection marks. Being unemployed might also make it easier for you to file for Chapter 7. This is because your unemployment income will probably not be high enough to make you ineligible for Chapter 7 based on income considerations. Some bankruptcy courts (though not all) may not even require you to include unemployment compensation as income on your means test. (To learn more about income qualifications for Chapter 7, see The Chapter 7 Means Test.)
If you expect to soon be re-employed and earning enough to get back on track with creditors, you might be able to avoid bankruptcy.
If you decide to file Chapter 7 while unemployed and are fortunate to find a job after filing, this will not usually result in a denial of your discharge. But if you file a Chapter 13, the change in your income could impact your Chapter 13 plan payments. This is because you are required to commit all of your disposable income into your plan. For more information, read Can I File for Bankruptcy If I Am Unemployed?
If you cannot or do not wish to file either Chapter 7 or Chapter 13 bankruptcy, some other options you should consider, other than doing nothing, include:
negotiating payment plans with your creditors, if your unemployment benefits can handle it, or
selling or refinancing your home and using the proceeds to negotiate reduced lump sum payments to creditors.