Bankruptcy is not a get out of jail free card for your debts, it’s a nuclear weapon. If you use it, expect to be considered credit unworthy for a decade.

A lot of people believe that if they fall behind on their debts, bankruptcy is the quickest way out. Much like the scammy get rich quick infomercials you see at 3 AM, bankruptcy sounds wonderful but is in reality an awful experience.

There are two types of personal bankruptcy – Chapter 7 and Chapter 13. Chapter 7 is total liquidation where all of your possessions are sold to help pay off the debt. Chapter 13 is known as the “wage earner’s plan” and is used to help restructure the debts so that the debtor can work towards paying them off over the course of several years. Local laws will affect how each type of bankruptcy is administered and what is protected but the basics are the same everywhere.

So why is bankruptcy bad? It’s bad because Chapter 7 and Chapter 13 bankruptcy is recorded on your credit report for ten years. For ten years you’re going to have to deal with explaining why you went into bankruptcy and for ten years it’ll be difficult for you to get a loan. It’s not impossible, but it’ll be difficult. The FHA will insure a mortgage two years after a Chapter 7 bankruptcy as long as you can show you’ve changed your ways. They will also insure a loan for someone one year after a Chapter 13 bankruptcy as long as they have stayed current on the plan payments.

What about a car loan? The rates are going to be very high. Bankrate offers up some tips on how to secure post-bankruptcy car financing and they quote double digit rates. Bankruptcy won’t preclude you from loans, but it’ll force a higher level of scrutiny.

What about the “other” areas your credit is used, like by landlords or employers? Bankruptcy Code § 525 protects someone who has declared bankruptcy from discrimination but it’s often difficult to prove bankruptcy discrimination. If you were a landlord and had to choose between two renters, one who had declared bankruptcy or one who hadn’t, which would you choose?

Bankruptcy won’t solve all your problems and the people who go that route often have no other choice (which is why so many people report having higher credit scores after declaring bankruptcy). The best advice is to never let yourself get in this situation in the first place, but if you are, you should be aware of what’s in store for you.

What do you think about bankruptcy? Think it’s still too easy to start over? Think it’s too hard?

Jim writes about personal finance at his personal finance blog, Bargaineering.

(Photo: andrewbain)

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