Should You Consider Filing for Credit Card Debt Bankruptcy?

When your well-being is threatened by excess credit card debt, bankruptcy might be a reasonable option.

CBS News recently reported that inflation pushed American credit card balances up by 13% over 2021 levels and that average credit card interest rates have hit 18.4% as of October 2022. Higher balances plus rising interest rates can make it difficult to keep up with monthly payments, especially when your earnings have not kept pace. 

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 your bring your account current. 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 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 being 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

While bankruptcy can get you out of credit card debt, it’s not a painless solution. For one thing, running up your credit card balances right before filing will not go unnoticed. According to legal site Nolo.com:

“Suppose you use your credit cards within 90 days before bankruptcy for luxury goods and services totaling more than $800. In that case, the bankruptcy court would presume you committed fraud (figures apply to cases filed between April 1, 2022, and March 31, 2025). (11 U.S.C. § 523(a)(2)(C)(i)(l).)

The bankruptcy court will also presume fraud if you take cash advances of more than $1,100 within 70 days before filing bankruptcy (amounts apply to cases filed between April 1, 2022, and March 31, 2025). (11 U.S.C. § 523(a)(2)(C)(i)(l).)”

In bankruptcy, you also won’t be able to discharge credit card balances used to pay debt that’s not dischargeable in bankruptcy – like taxes. 

Can you file bankruptcy only for credit card debt?

You cannot legally pick and choose which debts to discharge and which you want to pay. You have to list all debts, and the court decides who gets paid what, depending on their legal positions and agreements with you. 

That said, you’re perfectly free to pay a creditor after the bankruptcy ends if you choose to do so. You may 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. 

Chapter 7

Chapter 7 is the “clean slate” or “liquidation” bankruptcy. That means you surrender so-called “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 and what they take. However, assets like work tools, a modest car, and retirement accounts are usually exempt from bankruptcy.

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.

• You’ll 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, etc.

• The automatic stay stops collection activity from creditors.

• The bankruptcy trustee holds a meeting of your creditors. Be prepared to answer questions and provide any documents the trustee requires. 

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

• The assets are sold and the proceeds distributed among your creditors. 

• You receive a Chapter 7 discharge and your balances are cleared.

A Chapter 7 filing can remain on your credit report for up to ten years.

Chapter 13

Chapter 13 is the “earner’s” bankruptcy. If you qualify to file Chapter 13, you can keep all of your property. To discharge your debts, you’ll pay into a bankruptcy plan every month for three-to-five years. 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:

  • Being up-to-date on tax filings.

  • Your secured debt cannot exceed $465,275 and unsecured debt can’t be more than $1,395,875.

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

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

• You’ll 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, etc.

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

• The bankruptcy trustee holds a meeting of your creditors. 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 can pass the means test). 

• 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). 

Struggling with credit card debt but don’t want to file bankruptcy? What can you do?

There are reasons that bankruptcy might not be right for you. First, you can’t control the entire outcome. If your work involves finance or sensitive data, you also may not be eligible for certain jobs after bankruptcy. Finally, two-thirds of Chapter 13 filings fail, mainly due to high payments that filers can’t sustain year after year.

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 does not 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 are not 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.