Avoid Bankruptcy With These Simple Tips

Bankruptcy is often described as a last resort for people who are unable to pay their debts—and rightly so. Although it is sometimes a person's only alternative, bankruptcy has serious consequences that can follow them for years. This article lays out some common sense ways to avoid bankruptcy if at all possible.

Why It's Best to Avoid Bankruptcy

The two types of bankruptcy most often used by individuals are Chapter 7 and Chapter 13.

Both Chapter 7 and Chapter 13 bankruptcies will remain on the person's credit report for years to come (10 years in the case of Chapter 7, seven years for Chapter 13), making it far more difficult for them to obtain credit in the future.

Bankruptcy can also be a bright red flag to insurance companies, employers, and landlords that obtain the person's credit report. In many cases they will use credit reports as a way to assess how responsible a person may be.

How to Avoid Filing for Bankruptcy

While unexpected medical bills or a sudden job loss can put almost anyone in a difficult position financially, people facing bankruptcy may also be in that situation because of poor spending and saving habits. Here are some steps that can help no matter why your finances have become precarious.

Try to Minimize Spending

The first step in getting control over your finances is to figure out how much you spend each month and where it's going. Putting together a simple budget, boring as that may sound, is the quickest and easiest way to go about it.

The next step is to find ways to cut your spending. Lock your credit cards in a drawer (or give them to a trusted friend for safekeeping) and try to pay with cash—whether the actual green or through a debit card or smartphone linked to a cash account—whenever possible. (It's better not to cancel your credit cards because you'll reduce your credit limit and increase your credit utilization ratio, which is bad for your credit score.)

If you can't sustain your lifestyle on an all-cash basis, take that as a signal that you need to economize. This includes both the big and small stuff because every penny counts (though dollars count more than pennies). Some of the big-ticket ways to cut back are:

• Move to a smaller home (but do the math to make sure you'll really save after accounting for all the related costs)
• Keep your car longer before trading it in (and if you have more than one car, consider selling one of them)
• Sell the boat, motorcycle, or recreational vehicle if you happen to have one
• Skip going on vacation this year

At the small end of the spectrum, look for ways to cut your spending down to the absolute basics. In particular, take a hard look at what you spend on:

• Cable TV, streaming, and wireless services
• Dining out
• Gym and other club memberships

Gift giving at the holidays can be eliminated, too, for the time being. Spend time with the ones you love, not money on gifts they may not want anyhow. These steps might not be much fun, but bankruptcy isn't fun either.

Look to Maximize Income

Once you've minimized your overhead, you may still not have enough money coming in to pay for your living expenses in cash. If that's the case, see if you can increase your income. The most obvious way to do this is to get a job if you don't already have one. If you do have a job, consider taking on a second one in whatever free time you have available. The same applies to your spouse or significant other.

You might also bring in a little income by selling off some of the stuff you bought during your freer-spending days. Another possibility: take in a roommate to share your housing costs.

If you think you might qualify, don't hesitate to apply for assistance, such as through the federal government's Supplemental Nutrition Assistance Program (SNAP), formerly known as food stamps. Medicaid, if you're eligible, could cover some of your health care costs.

Consider Consolidating or Settling Debts

Debt consolidation, in which several high-interest debts are paid off with one lower-interest loan, is often mentioned as a tool to avoid bankruptcy. If you qualify for such a loan, consolidation can be a good strategy, as long as it doesn't become an excuse to start overspending again.

Debt settlement is another possibility. In a debt settlement, you or a company you hire will try to negotiate with your creditors to see if they will reduce your debt. The idea is that if you agree to pay a portion of the debt off now, they will forgive the rest of it—on the theory that they might get nothing at all if you declare bankruptcy. This is an area that is rife with fraud, so if you're considering hiring a debt relief company, check them out thoroughly first.

A not-for-profit credit counseling agency could also be of help here. These agencies can advise you on ways to get out of debt and help you negotiate with your creditors. For example, a creditor that is unwilling to settle for less than it is owed might be amenable to lowering your interest rate, allowing you to stretch your payments out over a longer period of time, or to some other accommodation that will make the debt easier to repay.

Before filing for bankruptcy, individuals are now required by law to obtain pre-bankruptcy credit counseling from an agency approved by the U.S. Trustee Program.

The Bottom Line

People can find themselves contemplating bankruptcy for many reasons, not all of which may be their fault. And sometimes bankruptcy is their only alternative. But if you can make a sensible plan to get out of debt and stay out of debt—and stick with it—you may be able to avoid bankruptcy and all the additional problems that accompany it.