Bankruptcy Explained [Definition, How It Works, Pros & Cons]

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Debt can be a serious problem. One of the ways of managing debt is by declaring bankruptcy. But what does this mean? This article addresses what bankruptcy is and when and how you should apply for bankruptcy, and how to recover from it.

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What Is Bankruptcy?

What is the definition of bankruptcy? It’s a form of insolvency that writes off a debt you can’t afford to repay, giving you a fresh start, debt-free. Bankruptcy is a legal status that lasts for one year with the purpose of clearing your debts. You can be declared bankrupt in one of two ways:

  1. A creditor can apply for your bankruptcy.
  2. You can declare bankruptcy yourself.

Before you apply for bankruptcy, it’s essential to remember that bankruptcy is a big step and should be used only as a last resort and involves specific fees.

(In Scotland, bankruptcy [known as sequestration] works differently than in England, Wales, and Northern Ireland.)

What Happens When You Declare Bankruptcy?

When you declare bankruptcy, all the assets you own—such as a vehicle or property—will be seized and sold to pay back your debts. Certain exempt goods, however, won’t be treated as assets in the bankruptcy process, including, for example, household items and equipment or tools you need for work.

After your assets have been sold, the creditors will write off your unsecured debts, and you’ll be required to make payments towards the remainder of your debt in the following three years. The payments will be based on your income and expenses. Your bank account will also be suspended in most cases, making it difficult to open a new one.

What Happens if You Declare Bankruptcy and Your Circumstances Change?

Suppose your circumstances change in the course of the bankruptcy. For example, if you start earning more money, you’ll need to pay more towards your remaining debt. In that case, you need to let the official receiver (OR) know about any changes in your income or expenses so that they can adjust your payments accordingly.

Regardless of the circumstances, you’ll still be obliged to pay rent and utilities, court fines, student loans, and any new debt you’ve accumulated after declaring bankruptcy in the UK.

The good news is that bankruptcy only lasts a year, after which you’ll receive a bankruptcy discharge, allowing you to be free of debt. Even though you must meet the deadlines for regular monthly payments, the court exempts the debtor of the obligation to repay their debts after the discharge.

DID YOU KNOW? In Q4 2021, there were 1,824 bankruptcies—a 2% increase compared to the previous quarter.

The Effect of Bankruptcy on Credit

Does bankruptcy harm your credit rating? Not only does bankruptcy affect your credit file, but it also significantly lowers your credit rating. Bankruptcy remains on your credit file for six years, and all details of your bankruptcy are recorded in the government’s insolvency register.

When lenders and banks look at your credit file, it’s unlikely they’ll approve you for any loans until the bankruptcy is discharged. And even then, they may be reluctant to approve you for a loan until you’ve managed to improve your credit score.

How Does a Bad Credit Rating Affect Your Life?

Going bankrupt with no assets in the UK can also make it challenging for you to rent a property, obtain insurance, or open a bank account and get a direct debit card. Even prospective employers may decide not to employ you because of your credit history.

And if you do find a lender willing to lend you money, they’ll probably charge you a high-interest rate, as they see you as a high-risk customer since you’ve shown that you can’t manage your past debt.

How to Go Bankrupt and Maintain a Good Credit Rating

Your credit rating will inevitably be affected, but you need to improve it if you want a sound financial future. The best way to go about this is to make your payments on time and prove that you can manage your finances. You could also take out credit for people with bad credit. These typically have high-interest rates but are good for improving credit scores.

DID YOU KNOW? Before you apply for bankruptcy, consider other debt solutions. First and foremost, you can cancel your credit card to avoid unnecessary spending and paying interest rates.

Bankruptcy Pros and Cons

You may still be unsure about what happens when you are declared bankrupt and if there are advantages to it. The following includes the pros and cons of declaring bankruptcy.

Pros

  • Unsecured debts are written off.
  • Creditors can’t take legal action against you.
  • You can keep some of your income.
  • You keep making payments for only three years.
  • You get a fresh start.

Cons

  • You need to pay a £680 fee.
  • Your assets may be seized.
  • You may lose your job.
  • Your credit score will plummet.
  • The bankruptcy is recorded on a public register.

When contemplating the pros and cons of bankruptcies in the UK, you also need to consider all options to understand if bankruptcy is the only way to go.

DID YOU KNOW? If you have trouble paying off your unsecured debts, consider taking out a secured loan, such as a mortgage, vehicle, or savings-secured loan. If you already have a mortgage, remortgaging can be a good idea, too.

Key Takeaways

Bankruptcy is a form of insolvency that writes off a debt you can’t repay.
All assets in your name will be seized and sold when you declare bankruptcy.
Bankruptcies stay on your credit file for six years and lower your credit score.
A bankruptcy application can be submitted online and includes a £680 fee.

How to Declare Yourself Bankrupt in the UK

If you’re familiar with what bankruptcy entails and you’ve decided it’s the right course of action for your financial situation, it’s essential to know how the process works. Our following step-by-step guide will help you apply for and declare bankruptcy.

#1 Fill Out an Online Application

When applying for bankruptcy, first register for an online account and fill out an online application on the government website. You’ll need to provide detailed information on your debts, employment status, income, assets, and expenses. Typically, you should receive an answer in around 28 days.

#2 Pay the Fee

If you wonder how to go about bankruptcies in the UK after filling out the online application, the next step requires you to pay a £680 fee. You can pay it online, apply to have it paid in installments, or pay in cash via a bank.

#3 Withdraw Money From Your Bank Account

Since your bank account will likely be closed as soon as the bankruptcy order arrives, it’s a good idea to withdraw money for living costs before this occurs. The bankruptcy order will freeze all your assets, so make sure you have enough money to get by.

#4 Confirm the Information & Agree to a Credit Check

When going bankrupt to clear debt in the UK, you’ll be asked to confirm all the information you’ve submitted on the application and your identity. You must also agree to a credit check. Remember, you need to provide the correct information; otherwise, you’ll be charged with a criminal offense.

#5 Wait for the Bankruptcy Order

After confirming your information and agreeing to a credit check, you must wait for the official decision. If you’re not approved for bankruptcy, you can request that your application be reviewed again. But if you receive the order, you’re officially declared bankrupt.

#6 Co-operate With the Official Receiver

Knowing how bankruptcies work includes your willingness to co-operate with the official receiver. You’ll have an interview with the OR, discuss the bankruptcy, and agree to notify them about any future changes in your circumstances.

DID YOU KNOW? When applying for a loan, consider the Annual Percentage Rate or APR, which represents the yearly interest rate on the loan.

How to Recover From Bankruptcy

What happens if I declare bankruptcy and cannot recover from it? You do need to start recovering from bankruptcy immediately. Fortunately, there are several actions you can take to get back on track.

  • Open a new bank account: Your current bank account will likely be closed. So you need to try to open a new account in a different bank or building society.
  • Acquire a copy of your credit report: It’s crucial to ensure that all the details stated on the report are correct and report any irregularities you find.
  • Add a statement to the report: It’s wise to add a statement explaining why you owe money, e.g., redundancy or illness.
  • Register for the electoral roll: What is bankruptcy in regards to your credit score? You must know that it impairs your score. But registering for the electoral roll at your current address can boost your credit rating.
  • Take out credit: There are credit cards and loans designed for those with bad credit. Check to see if you are eligible for one of these and apply.

These are just some steps you can take to recover from bankruptcy. But remember, bankruptcy is not the end of the world—you can recover and have a fresh start.

DID YOU KNOW? There is no minimum amount of debt you need to have to apply for bankruptcy. The only requirement is that the value of your assets isn’t greater than the amount of your debt.

Conclusion

Now that you know the pros and cons of bankruptcy, how the process goes, and how to recover from it, you can decide if filing for bankruptcy is the right way of handling your debt situation. And remember, you can also recover from bankruptcy.

FAQ

Why would a person file for bankruptcy?

A person would consider filing for bankruptcy when they have an unmanageable amount of debt, and the only option they have left is bankruptcy. This is often the last resort for many indebted people.

What is the downside of filing for bankruptcy?

Bankruptcies affect your credit score and lower your chances of being approved for a mortgage or another loan. It can also be more challenging to rent a property or even get a job.

Does bankruptcy clear all debts?

Some may ask ‘what is bankruptcy?’ in hopes of eliminating all of their debts. But with bankruptcy, you still need to pay off other certain obligations, such as student loans, court penalties, or fines issued by the state.

ABOUT AUTHOR

I learned a lot about finance after working for a digital marketing company specializing in investing and trading stocks, forex, etc. After that, I got exposed to other verticals such as wealth management and personal finance, which further improved my understanding of the financial world.

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