How Bankruptcy Works for Credit Card Debt
11 MIN READ
Published June 27, 2023 | Updated December 10, 2023
Credit card debt is a fact of life for many American families today, with an average debt of $5,910 per household. While it may not seem like a significant amount, that debt can keep growing over time. Bankruptcy for credit card debt is meant to give borrowers a second chance.
At some point, your debt payments may become unmanageable, and that’s when you may ask the question, “Should I file for bankruptcy for credit card debt?” There’s no right or wrong answer to this question.
Bankruptcy can help you eliminate most unsecured debts, including credit card debt, but it comes at a cost. You should consider several things before you choose this option, from the type of bankruptcy to file to how it impacts your financial future.
Risks of Falling Behind on Credit Card Payments
Your debt can snowball quickly if you don't stay caught up on your credit card payments, While you're unlikely to go to jail for not paying credit card debt, here are a few things that may happen as you start missing your monthly payments.
Higher Fees and Interest Rates
Credit card companies are interested in recovering their money. Once you start missing out on your payments, your credit scores will fall. This may result in you getting high-interest offers on other credit cards and loans.
When you're already struggling to make payments, higher interest rates can make things worse. Additionally, your card company will charge late fees. Although they may seem like a small fee, they can accumulate quickly and add to your credit card balance.
Once your credit card debt becomes significant, your account may be sent to debt collectors, and you'll start receiving collection calls and letters. In some situations, credit card companies may take additional action, such as filing for a debt collection lawsuit.
If you still fail to pay your credit card bills, there may be a judgment against you, which can continue to accumulate interest charges until you pay. When a card company files a lawsuit against you, wage garnishment is also possible.
Understanding Bankruptcy for Credit Card Debt
Filing bankruptcy for credit card debt may be a good way to get a fresh financial start and relieve some of your stress. However, CEO and Founder of Greenbacks Consulting LLC, Teresa Dodson, offers this advice: “Bankruptcy is in some cases the right solution, but should always be the resort.”
What Is Bankruptcy for Credit Card Debt?
Bankruptcy is a legal process initiated when you cannot repay your outstanding credit card debt and other financial obligations such as medical debt, utility bills, and personal loans. It provides a fresh start to those who can’t afford to pay all their bills.
The process begins when you file for a petition. All of your assets will be evaluated and measured. These assets may then be used to repay a part of your outstanding debt, depending on the type of bankruptcy you file.
Types of Bankruptcy for Credit Card Debt
While there are several different types of bankruptcies you can file, the most common options for eliminating credit card debt are Chapter 7 and Chapter 13.
Chapter 7 Bankruptcy for Credit Card Debt
Chapter 7 bankruptcy can wipe out all types of unsecured debt, including credit card debt. Dischargeable debt through Chapter 7 bankruptcy includes:
- Phone bills
- Back rent
- Personal loans
- Utility bills
- Medical bills
Debts that can’t be wiped out with this type of bankruptcy include alimony, child support, taxes, any debt you accumulated through fraud, legal judgments, and student loans.
If you own any non-exempt property, such as a second car, second home, or luxury goods, they may be sold by a bankruptcy trustee. The proceeds will then be used to pay off credit card companies and other creditors.
Chapter 13 Bankruptcy for Credit Card Debt
Chapter 13 bankruptcy is sometimes called “wage-earners bankruptcy” because it allows people with a steady income to restructure their debt and repay some of their creditors. With this type of bankruptcy, unsecured debt is given low priority.
When filing for Chapter 13 bankruptcy, you’ll be required to submit a plan to a bankruptcy trustee that mentions that you’ll pay most of what you owe within three to five years. Chapter 13 is often preferred over Chapter 7 because it allows you to retain valuable assets such as your home.
The next step in the process is to prioritize all your debts, starting with secured debts and priority debts such as back taxes, alimony, and child support. Next, you'll handle your unsecured debt. Once you make the required payments according to the plan, all debts will be discharged, including any credit card debts.
Should You File for Bankruptcy for Credit Card Debt?
Filing for bankruptcy to manage your credit card debt does have a few benefits. But here are a few questions to consider first to make sure it's the right decision:
- What's your total credit card debt?
- What's your total income?
- What's the interest rate on your credit cards?
- What other types of debt do you currently have?
- Are you expecting your income to change in the future?
- Are you willing to have bankruptcy on your credit report for 10 years?
- Are you looking to make any big purchases in the next few years where your credit score is important to qualify?
If you have a limited amount of debt other than credit cards, filing for bankruptcy just for credit card debt may not be right for you. Start by exploring other debt-relief options to weigh their pros and cons, and decide which option may be right for your situation. Consider getting legal advice to make an informed decision.
Filing for Bankruptcy for Credit Card Debt
Once you weigh your options and decide that you want to file for bankruptcy for credit card debt, you’ll need to find and hire a bankruptcy lawyer. Here's what you can expect throughout the process.
What Happens When You File Bankruptcy for Credit Card Debt
If you have a lot of credit card debt, you may be receiving phone calls and collection letters, affecting your daily life and causing financial anxiety.
Once you file for bankruptcy, all of that may stop due to automatic stay. An automatic stay will take effect right after you file for bankruptcy, meaning your creditors won't be able to take any actions to recover debts until the case has been resolved.
All bankruptcy cases go through the federal courts in the United States, and decisions are made by a bankruptcy judge. A trustee will handle the administration and will represent your estate in the bankruptcy proceedings.
You'll receive a discharge when you've completed all your duties. At this time, your licensed insolvency trustee will be discharged. A trustee also has to fulfill certain duties before you can be discharged, such as:
- Ensuring that income returns are filed.
- Making sure the final account of all funds is in the bankruptcy estate.
- Reviewing creditor claims.
- Distributing money to creditors.
The steps involved in filing for bankruptcy are:
- Collecting Financial Records: Make a list of all your debts, expenses, income, and assets. This will provide you and the court with an understanding of your finances.
- Getting Credit Counseling: You can only file for bankruptcy after you’ve gone through mandatory bankruptcy counseling. If you fail to get counseling, your bankruptcy filing may be rejected.
- Filing your Petition: Although you can file a petition without a law firm, bankruptcy is a serious undertaking that requires a thorough understanding of state and federal laws. A bankruptcy lawyer can help you file the petition with the right documents and forms.
- Meeting with Creditors: Once the petition is accepted in court, a trustee will set up a meeting with all your creditors to give them the opportunity to ask any questions they may have. You'll be required to attend the meeting.
Depending on the type of bankruptcy you file for, you'll be expected to pay a case filing fee of $235-$245 and an administrative fee of $75.
Bankruptcy as Credit Card Debt Relief
Filing bankruptcy is a last-resort option, but in many cases, it may be necessary to help you to get back on your feet. There’s no minimum debt amount for filing. If you've been struggling with paying your bills and your debt is so unmanageable that other debt-relief options such as debt consolidation or debt settlement are not an option, bankruptcy may provide you the reprieve you need.
Discharge Process for Credit Card Bankruptcy
Once you've filed for bankruptcy and received a discharge order, you are no longer required to pay off your debts specified in the bankruptcy discharge order. Creditors that are listed on the order will have to cease collection activities.
Not all debts may be discharged, such as child support, tax claims, alimony, and any debts you owe to the government. Additionally, secured creditors may still enforce liens against any property you own.
If you're filing for Chapter 7, discharging credit card debt may take up to four months. For Chapter 13, discharge may happen whenever it's practical. Filing for bankruptcy for credit card debt can also negatively impact your credit for seven to ten years. But, once you start making sound financial decisions and managing your debts well after bankruptcy, you may see your credit scores start rising again.
Bankruptcy for Credit Card Debt: Factors to Consider
Filing for bankruptcy is not a decision that should be taken lightly. Here are some of the most important factors you must consider before you make a decision one way or the other.
Eligibility for Credit Card Debt Bankruptcy
The eligibility requirements for bankruptcy will depend on the type you plan to file. For example, for Chapter 7 bankruptcy, your total income in the last six months should be lower than your state’s median household income. You may also have to undergo a means test to assess your ability to repay debts.
Bankruptcy courts will also consider other factors, such as the reason for filing and if you have filed for bankruptcy before. If you're filing for Chapter 13 bankruptcy, you must demonstrate that you have the means to make the debt payments as outlined in your reorganized debt plan. You must also be up to date on filing your tax returns within the last four years.
Impact on Credit Score
One of the main reasons why bankruptcy is considered to be the last resort is because of the significant impact it has on your credit history. Chapter 7 will stay on your credit report for ten years, while Chapter 13 will stay there for seven years. During the first few years, it will be challenging to get access to financing or credit.
Bankruptcy can impact your ability to get new credit as well as complicate insurance premiums and employment. It is possible, however, to recover your credit scores. As you continue to practice responsible credit behavior, your credit scores will improve, and the impact of bankruptcy will become softer. Credit repair will not be easy or quick, so it is important not to lose morale.
Financial Future After Bankruptcy
Filing for bankruptcy for credit card debt may have an impact on your financial future. As discussed earlier, your credit scores will take a hit, and that will make it harder for you to get a conventional credit card or bank loan.
There are lenders that may still be willing to work with lower credit scores, but the cost of borrowing will be much higher. To not get sucked into the cycle of debt again, it's best to avoid borrowing after bankruptcy until you're able to recover financially.
Pros and Cons of Bankruptcy
If you're trying to decide whether bankruptcy is the right choice, consider these pros and cons.
- Helps you avoid legal judgment.
- Wipes credit cards and other unsecured debts clean.
- Allows you to recover from default.
- Doesn't discharge all debts.
- Allows for repossession of collateral
- Negatively impacts your credit score.
Bankruptcy for Credit Card Debt: Final Thoughts
Bankruptcy is a process that allows you to get rid of several types of debts, stop collection calls, and get a fresh start. Chapter 7 and Chapter 13 are the two most common types of personal bankruptcy options, and they allow you to discharge debts by liquidating assets or by creating a repayment plan. Consider talking to a bankruptcy attorney or a financial counselor before you file for bankruptcy for credit card debt.
If bankruptcy is not right for you, you can also consider debt settlement to deal with your credit card debt. TurboDebt can help you manage your debt through consultation, planning, and debt relief services.
Our debt professionals can help you find the right debt relief option based on your financial situation. Connect with us today for a free consultation.