Bankruptcy, the Final Frontier

When you've exhausted all options and you still can't get out of debt, there's always bankruptcy.

In the 1960s, the Starship Enterprise set off on a five-year mission to explore space, "the final frontier." If you've run out of answers to get out of debt, you might consider embarking on a multi-year journey of your own: bankruptcy.

Unlike Monopoly, the board game, life offers no "get out of debt free" card. The closest thing to it is bankruptcy, which is anything but a quick and simple solution-and anything but fun and games. The process is lengthy, and the outcome has long-lasting implications. On top of that, bankruptcy isn't the right solution for everyone-particularly for those whose problems are rooted in mortgage debt.

Elusive clean slate

Bankruptcy can be problematic for mortgage borrowers, because the court has limited authorization to alter mortgage debt. In a Chapter 7 filing, which involves asset liquidation and debt discharge, the bankruptcy court can't wipe away the amounts you owe to mortgage lenders. Nor can the court attempt to modify that debt to make it more affordable for you. The court will allow the lender to seize your property, which is essentially what happens in a foreclosure. That's one of the reasons why Chapter 7 bankruptcy should be considered a last-resort; it simply won't help you keep your house.

What a Chapter 7 filing will do, however, is remove the burden of excessive unsecured debt, something the courts can discharge.  This may be your incentive for filing. If your life and budget look significantly rosier without such debt, then bankruptcy is something to consider-even if it means losing your home.

Catch-up filing

A Chapter 13 bankruptcy won't discharge your debt, but it may allow you to keep your residence. Chapter 13 involves debt reorganization. Basically, you're protected from creditors while you repay past-due amounts over time. The drawback is that you also have to continue making your regular debt payments, including the one for your mortgage. But stick to the plan, and you won't have to move.

Chapter 13 is most appropriate when your debt problem was caused by temporary circumstances (that have now been remedied), rather than by over-borrowing.

Lasting consequences

The biggest problem presented by a Chapter 7 or 13 bankruptcy filing is the impact it will have on your credit score. The bankruptcy will remain in your credit file for seven to 10 years. For at least the first two of those, you won't qualify for unsecured or mortgage debt. If you choose to rebuild your credit history, the process will be slow and painful. This can be a tough transition, particularly if using credit was deeply entrenched in your lifestyle.

Incidentally, the Starship Enterprise's five-year mission is still going after 40 years. Should you choose to file for bankruptcy, you might find that living debt-free is a mission you'd like to pursue indefinitely.