what is bankruptcy, how does it work, how does it affect your credit, and what does it do?
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Bankruptcy is a legal process to alleviate the burden of debt without dealing with some of the consequences. In other words, you “declare” that you are unable to pay a debt and then legally it goes away. Well, that depends exactly, as there are several different kinds of bankruptcy. The idea is that if an individual or company absolutely cannot pay, it is better to resolve it officially and everyone move on with life than to destroy someone’s life over the matter. In the old days something like debtor’s prison could be an option if someone couldn’t pay debt.
In the early days of the US, bankruptcy was a particularly controversial subject. Many thought that bankruptcy laws were essential, otherwise few people would be willing to take risks to start new businesses or borrow money for research or to build new technology. The fact that bankruptcy is an option is a type of incentive towards risk taking and innovation. Others thought that a society of simple honest hard working people should not need bankruptcy and it was a conduit for fraud and corruption, and at odds with the esteemed philosophies associated with work ethic and honesty.
Bankruptcy can be very difficult to observe because sometimes you see someone who made some honest mistakes, got in over their head so to speak, or had a string of bad luck. Other times you see people who abused the system, ran reckless with credit and lived it up frivolously and then take advantage.
In very general terms the fact that bankruptcy is a possibility kind of builds in higher borrowing rates for everyone. I’m not saying it’s bad. But if a borrower goes bankrupt then the bank has to absorb those debts and it does that by charging other borrowers more.
In the US it has significant consequences for a credit record, but they can also be mitigated especially over time.
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