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Why many people file for bankruptcy when creditors file lawsuits

On Behalf of | May 21, 2024 | Consumer bankruptcy |

The decision to file for personal bankruptcy is often a difficult one. Most people would prefer to avoid bankruptcy if possible, because of its negative side effects. Someone who files for bankruptcy faces the closure of their revolving lines of credit. Their credit score drops significantly, and it may take them some time before they are eligible for competitive credit opportunities again in the future.

Those setbacks are temporary, thankfully, and filers can often improve their financial situations significantly with a bankruptcy. Still, many people who struggle financially make the decision to avoid bankruptcy even though it could prove beneficial for them. However, when a creditor files a lawsuit because someone is falling behind on their debts, that may finally push someone who has struggled financially for years to take assertive action.

Why do lawsuits lead to bankruptcy?

A creditor lawsuit is a very serious issue for someone who does not have enough income to meet all of their financial obligations. The courts generally do not care about the reason that someone has defaulted on a loan or fallen behind on payment plans. What matters is the legitimacy of the debt and the accuracy of the creditor’s claim that the borrower debtor is in arrears. The courts can garnish someone’s wages or grant a creditor a lien against their property. The outcome of a creditor lawsuit can drastically worsen someone’s financial circumstances.

Bankruptcy is one of the only ways to avoid the worst-case scenario when a creditor serves someone with lawsuit paperwork. The same day that someone files for bankruptcy, the courts give them an automatic stay. That stay protects them from collection activity until they obtain a discharge or the courts dismiss their case. When there is a pending creditor lawsuit, a bankruptcy filing typically leads to its dismissal. If someone can discharge the debt that led to a lender lawsuit, they don’t have to worry about facing litigation in the future.

Filing for personal bankruptcy can potentially protect someone from wage garnishment and other aggressive collection activity that could worsen their financial situation. It is often the drastic collection efforts taken by creditors that make people realize they need the protection of an automatic stay or the discharge of their qualifying debts.