Presidential candidate and Illinois Senator Barack Obama proposed changes to bankruptcy laws on Tuesday to make it easier for certain Americans to wipe away debt, but a new study reinforces the view that filing for bankruptcy may not be worth it.
Rules enacted in 2005 made it harder and more costly for Americans to file for Chapter 7, in which assets are liquidated and given to creditors, or Chapter 13, which structures a repayment plan for certain debts over a term up to five years. (Debts outside of the plan would not have to be repaid.)
However, Obama took note of the many Americans dealing with high costs and enormous debt burdens, saying that military families and those struggling with medical bills -- which cause about half of all bankruptcies -- should get a pass.
Whether bankruptcy laws get a major overhaul or not, those considering such a move should be aware of the consequences. Research conducted by professors at Ohio State University and the University of Maine found that financial damage caused by filing for Chapter 11 can be widespread and last for decades.
Overall, it can take over 20 years for bankruptcy filers to reach the same financial status as those with similar social and economic backgrounds who did not file for bankruptcy. It took more than a decade for a bankruptcy filer to catch up to peers in terms of savings, income and home ownership, according to the study. It took more than a quarter of a century to reach the same level of net worth.
Jay Zagorsky, co-author of the study and a research scientist at Ohio State, notes that high prices for gas, food and housing, combined with crushing debt, can make bankruptcy seem like an easy way out with a clean slate.
"But," he adds, "to experience what people may heard of as a 'fresh start,' that may take longer than they expect or would like."
The survey showed a few bright spots, but overall, bankruptcy wounds take a lot of time to heal. While those who went bankrupt were able to get a job and a car more quickly than their peers, they were also saddled with more car debt. The percentage of bankrupt respondents with car debt declines with time, but never reaches the lower 42% level of those who never filed.
Similarly, bankrupt respondents fared worse in terms of homeownership, savings and credit-card approvals, though rates improved over time, along with credit scores.
"On most measures, bankruptcy does set people back quite a bit," Zagorsky says.
The survey has been performed on the same group of 7,661 respondents more than 20 times since 1979. However, Zagorsky also notes that these most recent results are based on a survey performed before the 2005 bankruptcy laws were put into effect, and may actually mute the negative effects.
Those grappling with high costs and excessive debt should seek out other options first -- whether restructuring or consolidating debt, negotiating a payment plan or lower interest rates with creditors, selling off assets or simply cutting back on costs -- before putting a 20-year "scarlet letter" on their credit scores.
The Federal Trade Commission offers some tips for consumers who are "knee-deep in debt." The Justice Department also has a list of approved credit-counseling agencies that can offer advice on how to repair your financial position without succumbing to bankruptcy.