When Does Filing for Bankruptcy Make Sense?

Since 2008, high unemployment rates, plummeting housing prices and mortgage rate adjustments have got many Americans searching for a way to get out from under seemingly insurmountable debt. It's no wonder that many people have become so overwhelmed by reduction in income combined with overextended credit lines that they are running out of options and considering bankruptcy. In fact, 2008 witnessed one of the highest rates of bankruptcy filings in history, the seventh highest to be specific.

So when does bankruptcy make sense as a way to turn ones financial situation around? The answer is not specific, but some general guidelines posed by financial experts are as follows.

When Debt Reduction is Impossible Without the Courts Help

The purpose of the bankruptcy court, in essence, is to function as a mediator between a debtor and his or her creditors. The court, or more specifically, the bankruptcy trustee assigned to the case, is charged with the responsibility of examining a debtors income (or lack thereof) against creditors claims against him. If it is found that repaying the debt outside of bankruptcy is not feasible then the court will step in to either eliminate the debt, or force the creditors to accept a realistic repayment plan.

If Debts Cannot Realistically be Repaid in 3-5 Years

The specific time frame varies depending on who you ask, but if debts cannot be repaid within three to five years, then bankruptcy should be considered as an option. That doesn't mean bankruptcy is necessary, but rather should be weighed against other alternatives.

When a Job Loss Leads to Spending Retirement Assets

This one is important. All to often, a job loss or other reduction in income will force many Americans to begin withdrawing funds from and IRA, 401k or other retirement account. While a honorable effort, the most frequent outcome of this method is the debtor will find themselves in the same situation a few months down the road, only now without their nest-egg. Filing bankruptcy at this point loses some of its effectiveness, as the retirement accounts are gone and can no longer be protected.

Retirement assets are protected under US Bankruptcy law, so many financial experts advise against withdrawing any funds before getting legal advice from a bankruptcy lawyer.

When Mortgage Adjustment Creates an Impossible Situation

Recently, vestiges of the sub-prime mortgage market have been coming back to haunt honest homebuyers. Sold terrible loans that are now adjusting to unmanageable payments, these people are facing the loss of their home. While the Obama Administration has been making efforts to force banks into modifying mortgages, many refuse.

Now facing a foreclosure lawsuit, bankruptcy can get the court to step in and stop the foreclosure process, force banks to accept a lower payment, and allow homeowners a way to get caught up on delinquent mortgage payments.

What about Debt Settlement?

While there are some legitimate organization that will attempt to negotiate a creditors' claims against a debtor, most are pretty much a scam. Any company that asks to give them money up front should be avoided. It is always wiser and more cost effective for debtors to negotiate for themselves.

The Bottom Line

There is no one "rule" that will help struggling Americans decide if bankruptcy is the best choice for their situation. The best thing to do is attend pre-bankruptcy counseling to find out more about the options available, or talk to a financial expert or bankruptcy lawyer to learn about the advantages and disadvantages of petitioning the bankruptcy courts for protection and help.

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