Should You Consider Filing for Credit Card Debt Bankruptcy?

If your financial life has become unmanageable because of credit card debt, bankruptcy might be your best path forward. Filing bankruptcy can be a powerful form of debt relief, because it could allow you to get rid of some of your debts and begin a new financial trajectory. 

Bankruptcy may not always be the best choice for every person’s situation. Filing bankruptcy has a severe negative impact on your credit score and affects what kinds of new credit you’ll qualify for (for a few years, at least). Bankruptcy also typically requires you to hire a lawyer, deal with a public court process, and go through complex and sometimes stressful decisions where you can’t always control what happens next.

No matter what kind of financial struggles you’re going through, you’re not alone. And you have rights and choices for what to do next. Whether it’s filing bankruptcy or seeking other types of debt relief like debt settlement, you can get professional help to help you understand your options for how to get rid of debt faster. 

Let’s take a look at the big picture of how credit card bankruptcy works and how it compares to other options for debt relief. 

For personalized legal advice, consult with a qualified attorney licensed to practice law in your state.

What Happens When You Fall Behind on Credit Card Payments? 

Once you fall more than 30 days behind on your credit card payments, expect to hear from your credit card company—by phone, mail, email, and/or text. Your credit card issuer may also report your missed payment to credit bureaus, and you’ll probably incur a late fee of up to $41.

If you miss a second payment and fall 60 days behind, your credit card company may increase your interest rate (this is called a penalty rate or a default rate). The higher rate can stay in place for up to six months after you get up to date on your credit card debt payments. Of course, higher interest makes it even harder to afford your monthly payment. Your card issuer will continue to attempt to contact you during this time. 

After several months, your credit card issuer may write off the debt and sell your account to a debt buyer, send your account to a collection agency, or take you to court. Collections and lawsuit judgments get reported to credit bureaus as well—your credit score will drop.

If you lose in court or fail to show up, your creditors may be able to garnish your wages or take money from your bank account, and place a lien on your home. Your problem does not go away—it continues to escalate as long as you avoid asking for help.

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Why File for Bankruptcy? 

If you’re overwhelmed by creditor phone calls, collection letters, or lawsuits, filing for bankruptcy forces your creditors to suspend collection activity. This is called an automatic stay. The automatic stay remains in place until the bankruptcy court resolves your case.

The bankruptcy court’s purpose is to help you repay some or all of your debt in an affordable way, and to distribute that money among your creditors. Debt forgiven through bankruptcy is not taxable income to you. 

Credit Card Debt in Bankruptcy

Bankruptcy could free you from credit card debt, but it’s not an entirely painless solution. For one thing, running up your credit card balances right before filing will raise red flags with creditors and the court. If you’re considering bankruptcy, make sure you’re not using your credit cards to make big flashy purchases. 

Doing the following could cause problems for you in court: 

• Using use credit cards to buy luxury goods and services over $800 within 90 days of filing bankruptcy

• Taking out cash advances of more than $1,100 within 70 days of filing bankruptcy

Bankruptcy judges might suspect you of presumptive fraud, or of abusing the bankruptcy system. If you run up new credit card debt right before filing bankruptcy, credit card companies can challenge you in court and ask the judge to make those debts non-dischargeable. 

For all of these reasons, it’s a good idea to just stop using your credit cards for 90 days (or more) before filing bankruptcy. 

In bankruptcy, you also won’t be able to discharge credit card balances that were used to pay debt that’s not dischargeable in bankruptcy—like unpaid taxes or federal student loans. 

Can You File Bankruptcy Only for Credit Card Debt?

Bankruptcy is not only for credit card debt. Although many people might choose to file bankruptcy as a result of unpaid credit card debts, there’s technically no such thing as a separate kind of credit card bankruptcy. You cannot legally pick and choose which debts to discharge and which you want to pay. 

As part of the process of filing bankruptcy, you have to list all your debts in an official court filing. This list includes credit card debts, personal loans, and other types of debt like auto loans or home mortgages. The bankruptcy court then decides which of your creditors get paid, and in what amounts, based on each creditor’s legal position and agreements with you. 

For most people, the entire purpose of filing bankruptcy is to get rid of debts. But after bankruptcy, if you choose to do so, you can decide to pay a creditor back even if the debt was discharged (forgiven). 

You might also be allowed to reaffirm debt—for instance, the loan on a car that you need to get to work. In that case, you and your lender must sign a new contract. 

What Types of Bankruptcy Can You File?

The most common types of bankruptcy filings for individuals are Chapter 7 and Chapter 13. They have very different rules and eligibility guidelines. 

Note that technically, you could handle the process yourself. But people who hire a bankruptcy attorney tend to have better outcomes.

Chapter 7

Chapter 7 is sometimes called a liquidation or clean slate bankruptcy—though it doesn’t actually wipe the slate clean. You may have to give up some of the things you own. You surrender non-exempt assets, and then your debts (excluding certain types like government-backed student loans, taxes, or child support) go away. 

You don’t get to choose what you keep, but assets like work tools, a modest car, and retirement accounts are usually exempt from bankruptcy. Each state has a list of what you’re allowed to keep. You can follow your state’s list or the federal government’s list, whichever one benefits you the most.

Here’s how Chapter 7 works:

• You must pass a means test to file. This test confirms that your income is too low for you to repay any of what you owe your creditors. 

• You must complete pre-bankruptcy credit counseling before you can file.

• Your attorney will file your petition and provide this information to the court:

• All creditors and the amounts you owe

• The sources and amounts of your income

• All assets

• Details of your monthly living expenses like food, clothing, shelter, utilities, taxes, transportation, healthcare, and so on

• The automatic stay stops collection activity from creditors.

• The bankruptcy trustee holds a meeting of your creditors. Your attorney will attend with you. Be prepared to answer questions and provide any documents the trustee requires. 

• The trustee may require you to give up your non-exempt assets.

• The non-exempt assets are sold and the money is given to your creditors. 

• You receive a Chapter 7 discharge and your eligible balances are cleared. You no longer owe those debts.

A Chapter 7 filing typically remains on your credit reports for 10 years.

Chapter 13

Chapter 13 is the wage earner’s bankruptcy. If you qualify to file Chapter 13, you can keep your property. Before the court will discharge your debts, you’ll pay into a bankruptcy plan every month for five years (three years if you’re low-income). Once you complete your plan, any remaining balances are zeroed. The court determines how much you can afford to pay each month, and that amount can be high. 

Here’s how Chapter 13 works:

• You must be eligible to file. Basic qualifications include:

• Up to date on tax filings.

• Your secured debt cannot exceed $526,700 and unsecured debt can’t be more than $1,580,125.

• You must earn enough to cover the required monthly payment.

• You must complete pre-bankruptcy credit counseling before you can file.

• Your attorney will file your petition and provide this information to the court:

• All creditors and the amounts you owe

• The sources and amounts of your income

• All assets

• Details of your monthly living expenses like food, clothing, shelter, utilities, taxes, transportation, healthcare, and so on

• You and your attorney can submit your repayment plan with your petition or within 14 days of filing.

• The bankruptcy trustee holds a meeting of your creditors. Your attorney will attend with you. Be prepared to answer questions and provide any documents the trustee requires. 

• The bankruptcy judge holds a confirmation hearing. If your plan is confirmed, you’ll be told when and how to begin making your monthly payments. Otherwise, you’ll be given a chance to file a modified plan or convert your case to a Chapter 7 (if you qualify). 

• After making all plan payments and complying with every requirement, your remaining debts are discharged (except for non-dischargeable obligations like child support and government-backed student loans). 

What to Do Instead of Bankruptcy

If you’re struggling with debt but don’t want to file bankruptcy, you have some options. 

There are reasons that bankruptcy might not be right for you. For one, you can’t control the entire outcome—the court decides which of your debts get discharged and how much you have to repay to your creditors. Another reason not to file bankruptcy is if your work involves finance or sensitive data—you might be ineligible for certain jobs after going through a bankruptcy. 

Perhaps the biggest to opt for a different solution is that bankruptcy is not guaranteed to work. Chapter 7 is highly successful but not everyone qualifies. About half of Chapter 13 cases fail. 

Two common alternatives to bankruptcy include debt settlement and debt management.

Debt settlement

Debt settlement is similar to Chapter 7 in that the creditor gets a lump sum that’s less than you owe and then wipes out your balance. Debt settlement offers a few advantages over bankruptcy:

• It doesn’t create a public record, so your financial problems remain private.

• You don’t have to give up property. But if you want to sell an asset to come up with money for a settlement, you can. 

• You control the process and can’t be forced into an agreement you don’t want. 

• If you’re insolvent (your debts exceed your assets), amounts forgiven in a settlement are not taxable. 

Unlike bankruptcy, however, creditors aren’t required to settle and there is no guarantee that they will. They could choose to sue you instead. 

Debt management plan (DMP)

Debt management plans are very similar to Chapter 13 bankruptcies. With a DMP, a credit counselor contacts your unsecured creditors (like credit card companies) and tries to negotiate reductions in your interest rate and minimum payments. You generally have to close your credit card accounts. Then, your counselor creates a plan. 

You make a monthly payment into your plan and the counselor distributes your payment among your creditors. One common drawback is high monthly payments. To complete a DMP successfully, you need to make your payments on time. 

When to Choose Credit Card Bankruptcy vs. Other Debt Relief

Every person’s situation is different, and credit card debt bankruptcy can be the right choice for some people. Here are a few ways to know if credit card bankruptcy is right for you: 

• You feel that your credit card debts are too big to ever pay off

• You have suffered a major financial setback

• You don’t have confidence in your ability to complete a debt repayment plan

In those situations, credit card bankruptcy might be the best way to get rid of debt. But remember: you’re not alone. You can get professional help to understand your options. If you talk with Freedom Debt Relief, we’ll give you a free debt evaluation. During this free consultation, we can talk about your financial picture and help you decide if filing bankruptcy, getting credit counseling, or choosing a debt settlement program is the best fit for your needs.