Your 5-Point Checklist for Avoiding Bankruptcy

By Markets Fool.com

Some people look at bankruptcy as an easy solution to their financial woes, but in reality, bankruptcy is no picnic. A bankruptcy filing will remain on your credit report for seven years following a Chapter 13 repayment plan and 10 years following a Chapter 7 liquidation. During that time, you may find it difficult to get approved for a mortgage, rental, or car loan, and even if you are approved to borrow money, it will most likely be at an unfavorable rate. So if you'd rather avoid bankruptcy and the financial repercussions that come with it, here are five tips to follow.

Continue Reading Below

IMAGE SOURCE: GETTY IMAGES.

1. Create -- and stick to -- a budget

If you don't know where all of your money goes, you're more likely to overspend, and when that happens, you run the risk of not being able to pay your bills in full. By sticking to a budget, you'll have a better idea of how you're spending your money and whether you're spending too much.

On a basic level, creating a budget means listing your various expenses and estimating how much you're spending in each category, but there are plenty of tools and tips to help make your budgeting efforts even more successful. Ultimately, an accurate budget can help you avoid spending more money than you actually bring in.

2. Live below your means

Continue Reading Below

Creating a budget can help keep your spending in check, but if you're serious about avoiding bankruptcy, your goal shouldn't just be to not spend more money than you make. Rather, you should always aim to reserve a portion of your paycheck for savings -- ideally, 10% or more. Just because you technically earn enough to swing a $2,000 monthly mortgage payment, for example, doesn't mean that you should actually stretch yourself to that limit. Spending your entire paycheck means leaving yourself without a cushion in the face of unanticipated expenses.

Imagine, for instance, that your car suddenly needs more expensive repairs than your budget allows for. If you don't have any wiggle room in your budget, you'll risk coming up short on your bills.

3. Don't rely on credit cards

There are certain benefits to using credit cards, like racking up rewards points and having an easy way to keep track of the things you buy. But if you're going to use a credit card, do so because it's convenient -- not because you don't have the money to buy whatever it is you're looking to purchase.

Charging things you can't afford is a good way to embark on a slippery slope toward bankruptcy. You might start by charging one or two smaller items, thinking you'll pay them off in a few months' time. But what happens if you do the same thing month after month? Before you know it, you could find yourself deep in the throes of credit card debt. A much smarter way to use credit cards is to pledge never to charge anything you can't pay off in full by the time your bill comes due.

4. Unload the expenses you can't keep up with

Do you own a home where the maintenance costs seem to rise by the day? Are you now on a first-name basis with your local auto mechanic? Bailing on a major money pit might be the key to helping you avoid bankruptcy in the long term. If you're struggling to cover certain expenses, you're often better off cutting your losses and pursuing more affordable options.

5. Negotiate your existing debt

If you've reached the point where your debt has piled up and you can no longer keep up with your payments, there may be an option to explore before resorting to bankruptcy: negotiating and settling your debts. While there are debt-settlement firms that can guide you through this process, they also cost money, so it's worth first discussing things with your lenders on your own. You can start by asking your credit card companies for an interest-rate reduction, or requesting that your lenders write off a portion of your debt, and accept a lower payment in total.

Now you may be wondering why a lender or credit card company would even be willing to negotiate in the first place, but the truth is, if you file for bankruptcy, these parties risk waiting a long time to get their money, or not getting it at all. Your lenders might be amenable to some sort of settlement if you can sell them on the fact that it's in their best interest.

Remember, bankruptcy isn't a magical get-out-of-jail-free card. There are serious consequences to filing, While some people have no choice but to go this route, taking steps to avoid bankruptcy will put you in a much healthier financial situation in general.

The $15,834 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $15,834 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.Simply click here to discover how to learn more about these strategies.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.