A bankruptcy wipes out the debtor's resources to pay creditors. If one has some paid off property but defaults on some unsecured accounts why would he or she want to file for bankruptcy thus risking liquidation of his/her assets? What would be a rationale behind such a filing?

  • 2
    You are assuming consumers make rational decisions, they don't. – Pete B. Sep 22 '20 at 13:29

A bankruptcy wipes out the debtor's resources to pay creditors.

This is a bit of an overstatement. Bankruptcy comes in many forms. For individuals, the most common for is "Chapter 7", in which most of your debts are forgiven in exchange for a liquidation of assets to pay part of what's owed. Secured loans (e.g. car loan) can be taken care of before bankruptcy by just surrendering the asset (repossession) and making up the difference.

A bankruptcy will require the borrower to liquidate enough assets to pay off the debt. One doesn't necessarily have to lose everything

If one has some paid off property but defaults on some unsecured accounts why would he or she want to file for bankruptcy thus risking liquidation of his/her assets?

A house is typically exempt from liquidation if the borrower is current on the mortgage and doesn't have a lot of equity. There is also a "homestead exemption" that varies by state that can be used to protect a house in bankruptcy. But, if one has, say, a million dollar paid-off property, they will possibly have to liquidate it to pay off unsecured debt. I would suspect that is very uncommon, though. More than likely someone declaring bankruptcy will have little to no equity in their home that is well under the homestead exemption.

What would be a rationale behind such a filing?

It is the last resort to recover from crushing debt. It stops debt collectors from coming after you, threatening to sue, and generally harassing you. It typically reduces the overall debt burden and gets rid of exorbitant interest and fees that may have piled up.

It can also prevent judgments from being filed on you by individual creditors, or remove existing judgments. A lawsuit would require you to show up in court (hopefully hire an attorney), and if a judgment is placed against you, the payments can be taken out of your paycheck (up to a certain amount depending on local laws).

It also put you back on the road to get back to credit recovery within a few years.

  • 1
    Self-employed people get paychecks too, or they own a business that can also be targeted by creditors. A bankruptcy filing can protect those assets from being taken away. You're reducing the premise to a very narrow situation, ignoring the much more common scenarios that benefit by bankruptcy. – D Stanley Sep 22 '20 at 13:09
  • 2
    So maybe bankruptcy is not the best option for your friend, then? Maybe your friend wants to pay off his.her debts and wants to use a bankruptcy as a way of dealing with all creditors at once? Your friend should talk to a bankruptcy attorney and see what options are best for them. Your questions seems to question the viability of bankruptcy in general, not in a very specific case. – D Stanley Sep 22 '20 at 13:19
  • 2
    It sounds sounds like they have some financial support that indicates that they should just pay off their debts, not try to get out of them through a bankruptcy. – D Stanley Sep 22 '20 at 13:20
  • 1
    @sequence , everything you are saying in the comments is 1000% correct. YES, if you own assets (say, a house) and there is NOT an exemption in your jurisdiction, then you are TOTALLY CORRECT - in that circumstance it would be insane to follow a bankruptcy tactic. You're totally correct. But realize that that is usually NOT the case in most jurisdictions/situations. Usually you can "get away with" keeping most/whatever assets. – Fattie Sep 22 '20 at 13:21
  • 1
    @sequence Say you have purchased a house that is now worth $500k and you have $100k equity in it, plus another $100k of miscellaneous assets. In a state where the entire house is exempt, if you declare bk as-is, the creditors get $100k and you still have $100k equity (and also probably mortgage debt close to $400k). If you take your $100k miscellaneous assets and put it towards the house, then the creditors take $0 and you have $200k equity (and mortgage debt ~$300k). You will likely get foreclosed upon, but that's a separate process. – shoover Sep 25 '20 at 3:44

The answer is very simple,

why would he or she want to file for bankruptcy thus risking liquidation of his/her assets? ...

in many cases such folks have little or no assets.

So indeed, you're 100% correct that (in certain jurisdictions) if you, say, own a house, it would be insane to attempt bankruptcy, because it would be stripped from you. You're correct.

Note however that in many jurisdictions, if you go bankrupt you DO NOT have all assets stripped from you. So, that's the second answer to your question.

  • 1
    In most jurisdictions there are limits to what a debtor can be stripped of in a bankruptcy. For example, if a house is worth $40k or less then the house would not be liquidated to pay the creditors. The only issue is that rarely a house is worth that little :-) – sequence Sep 22 '20 at 13:31
  • 2
    @sequence I think the main issue with your focus is that you seem to be assuming that most people own their own homes - when in fact, many people rent. – Grade 'Eh' Bacon Sep 22 '20 at 13:34

In addition to D Stanley's good answer on more common ways bankruptcy may occur and some of the protections it can provide, it is also possible that someone may simply have more debt than assets. If your debt is eligible for discharge on bankruptcy (notable exceptions would include some student loan debt depending on jurisdiction), then bankruptcy may immediately increase your net asset position from negative something to near zero. Not a good position to be in after declaring bankruptcy, but 'good' is a relative statement!

  • 2
    @sequence See D Stanley's answer above, which talks about more likely bankruptcy scenarios, including where it is not uncommon for someone to have assets worth more than their debt, but may still benefit from declaring bankruptcy. In a case where I own a home worth $300k but have a $400k mortgage [house prices must have really dropped], and I am no longer able to afford the mortgage, I would rather walk away from everything then pay $400k over time for a house worth only $300k. If I am able to pay the monthly mortgage, I might choose to continue to live there if my house is under water. – Grade 'Eh' Bacon Sep 22 '20 at 13:07
  • 2
    @sequence , I notice you are making the same point repeatedly (quite reasonable on the internet!), YES you are CORRECT. Depending on the local jurisdictional laws, YOU ARE CORRECT that bankruptcy would be absurd (in those specific situations you point to). However, as everyone has mentioned repeatedly, that is RARE. Usually you can "get away with it". My impression is that you are "surprised" the law works that way - it's a case of "get used to being surprised" :O – Fattie Sep 22 '20 at 13:25
  • 1
    @sequence , my impression is your understand then, is simply wrong. You'd be amazed what you can "get away with". – Fattie Sep 22 '20 at 13:29
  • 2
    @sequence I'm going to have to echo Fattie here. In Texas, you can retain a homestead of unlimited value, a vehicle for each licensed household member, and $50k of personal property (twice that if married). Florida is similarly generous with homestead but less so on personal property, but allows well over $1m in IRAs and 401k (including ROTH). – Istanari Sep 22 '20 at 15:04
  • 1
    @sequence They can be, depending on the jurisdiction. Each state can be different. I suggest adding a "country" tag to your question, since it's clearly a critical piece of information. – Istanari Sep 22 '20 at 15:19

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.