As we develop our careers, accumulate assets, and work toward retirement, we all aspire to achieve financial security — whereby we are confident that our income and our assets are sufficient to meet our living expenses and provide for a lifestyle that is comfortable for us.
However, life doesn’t always work out according to plan; sometimes, financial security melts away, particularly for those who take risks with their money.
A string of bad investments — or a market downturn — can cause one’s nest egg to evaporate, as many investors learned during the financial crisis and stock market crash of 2008-2009. Or, if you are an entrepreneur and open a small business, you are certainly not guaranteed success. Even the most astute and conservative of small business owners can see their enterprises fail, often because of circumstances beyond their control. While the commonly cited statistic that “nine out of ten restaurants fail in their first year of operation” is a myth, some 60 percent of restaurants in fact do close down or change ownership in the first three years of operation — a percentage that holds true for all start-up businesses. It’s rough out there!
If you find yourself in over your head, what can you do? Declaring bankruptcy may seem like an extreme measure, but it’s worth a closer look. How can bankruptcy help you weather bad times? Indeed, what is bankruptcy?
Bankruptcy is Protection
In short, bankruptcy is a legal status, usually initiated by a debtor and imposed by court order, indicating that an individual or organization cannot pay debts owed to creditors. There are various kinds of bankruptcy that apply to different circumstances and entities, and that aim to achieve different results. Chapter 11 and Chapter 13 bankruptcy, for instance, are aimed at organizations and individuals, respectively; in both cases, the status allows a business to remain in operation, or an individual to continue to receive wages or other income, but both impose a strict budget, by court order, that allows creditors to be repaid over time. In a sense, these forms of bankruptcy are court-ordered debt restructuring plans. If you have a job and earn a salary but have simply gotten in over your head with credit card or other debt, Chapter 13 bankruptcy may be an option for you; if your business is legitimate and you are confident that you can eventually earn a profit, Chapter 11 bankruptcy is probably your best option. In either case, it may take three to five years to clear up your debts and emerge from bankruptcy status.
Chapter 7 bankruptcy, applicable to either individuals or organizations, is more severe. All of your assets are placed in the care of a court-designated trustee, who sells the assets for cash and distributes the proceeds to creditors. A company filing for Chapter 7 bankruptcy, therefore, will probably have to cease operations. If your assets are insufficient to clear all your debts, you will likely be discharged from any remaining debt. Chapter 7 bankruptcy can be completed in six months.
Bankruptcy Allows You Time to Reorganize
How can bankruptcy help you? For starters, it will get your creditors off your back. Whether you undergo debt restructuring or asset distribution, your creditors will be informed and will know how and when your debt to them will be paid off. Certain of your assets may be protected under a bankruptcy proceeding, namely your residence. If you’re a renter, bankruptcy may prevent an eviction; if you own your home, it may halt a foreclosure action. And, under Chapter 7, some of your debt may be eliminated.
Bankruptcy Is a Negative on Your Credit Record
There is, of course, a downside. A bankruptcy will be a black mark on your credit record; it will stay on your record for at least seven years. Everyone with access to your credit history, from prospective employers to insurers to new creditors, will see it. It will be more difficult for you to get new credit, and if you do, you can be assured that you will pay high rates. Likewise, if you’re job hunting, a prospective employer may be biased against your record (however unfairly), especially if you’re applying for a position that entails financial responsibilities.
Given the plusses and minuses, if you can work with a credit counselor to get a grip on your finances, that may be your best first option. However, for many individuals and businesses, filing for bankruptcy may become the only option. It doesn’t need to be as painful as it sounds.
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