In the U.S., debt is a serious financial issue. According to Debt.org, factoring in mortgages, the average debt in the U.S. is $101,915 per household.
When debt gets out of control, it’s common knowledge that bankruptcy is an option. However, it might not be as great of an option as it may seem.
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Rachel Cruze, personal finance expert and frequent co-host of “The Ramsey Show,” cautions you to pump the brakes if you think bankruptcy will definitely be an easy fix for your problems. In a recent episode, a caller explained that he was thinking about declaring bankruptcy after racking up $85,000 in credit card debt, but Cruze wasn’t keen on the idea.
Here are three reasons why you shouldn’t declare bankruptcy unless you have to.
1. It Follows You
Americans who find themselves in massive amounts of debt can turn to bankruptcy for relief. Bankruptcy stops creditors from collecting and eliminates or restructures the debt to give the debtor a fresh start. As Cruze acknowledged, “It sounds easy just to wipe it clean and start over.”
However, the issue doesn’t just disappear. Declaring bankruptcy means it will be on your credit report for years.
Chapter 7 bankruptcy, in which a trustee collects and sells your assets to pay your debt, may remain on your credit report for up to 10 years. Chapter 13 bankruptcy, which allows you to structure a repayment plan, stays on your credit report for up to seven years.
Even if you completely pay off your debt after filing for bankruptcy, the stain on your credit report will have lasting negative effects. Your credit score will drop by 100 to 200 points, so you’ll pay much higher rates for new credit cards, loans and mortgages. Your poor credit report may also limit your housing and employment opportunities.
While it can be challenging to get out of debt, doing so without bankruptcy allows you to maintain a cleaner credit report and enjoy the benefits that come with it.
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2. The Root of the Problem Doesn’t Change
Cruze referred to bankruptcy as an “easy button.” While it is a legal process that’s designed to relieve Americans in debt, there’s no guarantee that it will change how you think and act.
Serious debt often accumulates because someone has made numerous poor financial decisions over an extended period, and studies have shown that 16% of all bankruptcy cases are from repeat filers.
However, this statistic doesn’t account for individuals who have returned to debt after bankruptcy without filing again.
Cruze explained to the caller that it’s all about behavior. Pressing the “easy button” can help make your debt disappear, but it doesn’t provide the financial education you need to make sure the same problem doesn’t happen again.
Taking steps to pay off your debt without filing for bankruptcy will give you a better understanding of what you need to do to remain financially healthy.
3. There Are Other Options
Choosing bankruptcy as your first option to get out of debt is drastic and has negative long-term ramifications. Instead of immediately filing for bankruptcy, you should explore other options first:
Strategic Planning
Straightening out your debt issues is easier when you have a plan.
The debt snowball method, for example, involves listing all of your debt balances from smallest to largest and paying them in order, starting from the smallest. This method allows you to eliminate your balances one by one, increasing your motivation as you build momentum.
Similarly, the debt avalanche method also involves listing your debts, but this time they’re ordered by interest rate. Pay off the debt with the highest interest rate first and work toward the lowest. Doing this will save you money in the long run, which you can then put toward paying off more debt.
Consolidation
Debt consolidation can be an effective approach to getting out of debt and save you from the perils of bankruptcy.
This strategy involves taking out a new loan with a lower interest rate and using it to pay off all of your prior debt. A debt consolidation loan can simplify your situation as you have only one monthly payment to worry about.
You can also immediately pay off your high-interest debt and replace it with the lower interest rate of your new loan.
Negotiate
Some debtors may be unaware that they can negotiate with their creditors.
It’s in a creditor’s best interest to get back the money they loaned you, so being honest and explaining your financial issues may make them more receptive to your case. Propose a solution in the form of a payment plan, a reduced interest rate or a lump-sum settlement.
Even if your creditor disagrees with your plan right away, you may be able to find common ground and avoid filing for bankruptcy.
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This article originally appeared on GOBankingRates.com: Rachel Cruze: 3 Reasons To Not Make Bankruptcy Your First-Line Defense
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