When it comes to all the different causes of personal bankruptcy, can you guess which is most common? If you guessed credit card debt you're exactly right. Credit card bankruptcies are far and away the most common of all personal bankruptcies in the United States. Credit cards also represent the most risky form of credit for those who have difficulty managing their financial resources. So much so that there are a great number of people in our society who have no business using credit cards.
Credit card bankruptcy is not a legal term, by the way. It is simply a way for us to express that the root cause of a personal bankruptcy lies in excess credit card debt. It is no different than terms like "medical bankruptcy" or "student loan bankruptcy." In terms of legally recognized types of bankruptcy there are six. Each is designated according to the chapter of federal code where it's located. For example, there is chapter 13 reorganization for individuals and Chapter 11 reorganization for corporations.
The Problem with Credit Cards
Credit cards are a great idea for emergency situations when you don't have the cash to pay for car repairs, medical bills, and so on. When you have credit cards it's almost like carrying a personal banker in your back pocket. However, there are also inherent problems and risks with credit cards that often lead to credit card bankruptcies. Let's take a look at some of those here.
The first is the fact that a credit card is considered unsecured credit. Unlike a home mortgage, where your property becomes collateral for the loan, there is no collateral for your credit card debt. Because of that, many people use their credit cards in a way we would consider fast and loose. And because the lender has no ability to seize or foreclose on property, they are left up a creek when credit card users don't pay. For people who do not know how to control their spending, this access to unsecured credit is a license to keep spending right up to the limit of their credit cards.
The other problem with this type of debt is the fact that the interest rate you pay for credit cards is generally excessive. For those with extremely good credit and adequate income, credit cards can be had which charge between 7% and 9%. But that's not the real world for most of us. A credit card with 12% to 15% is more realistic for those of us who live in the real world. But that's just for starters. What happens if you make a payment late, or miss one all together? You will usually get socked with a penalty interest rate that can be nearly 25%.
When you think about interest rates it's easy to see how credit card debt can spiral out of control very quickly. So much so that one mortgage broker we read about online claimed he had several clients looking for home consolidation loans because they had upwards of $70,000 in credit card debt.
Getting out Through Bankruptcy
Using our previous example, if you had a $70,000 of credit card debt plus a mortgage, auto loans, and personal loans, do you think you could ever make enough money to pay them off completely? Most people don't. Further, the fact that interest is compounded annually means credit cards are a big reason for failed finances. If you find yourself in this position, and bankruptcy seems like the only solution, you have to decide whether to file Chapter 7 or Chapter 13. Both are bankruptcies designed for individuals and sole proprietorships; one is a total liquidation while the other is a reorganization.
Fortunately, credit card debt is dischargeable in most cases. That means when your bankruptcy is fully discharged all of your credit card debt will be settled one way or the other. In Chapter 7 liquidation that means the credit card companies were bound to accept whatever they could, even if it was very low compared to your outstanding balances. In a chapter 13 petition a successful discharge means that you have met the terms of your payment plan and repaid all of your creditors whatever they agree to accept.
Beware of Further Spending
Because using credit cards is such a strong temptation, many bankruptcy filers find themselves right back in the same position if they continue using them. One of the best pieces of advice we could give someone filing a credit card bankruptcy is to immediately cut up your cards and cancel your account. As painful as this may be, it may be the only option you have to control your spending. But it's okay. Believe me; it is possible to exist in this world without credit cards.