Bankruptcy is a legal proceeding in which a person who cannot pay their bills can get a fresh financial start.
Bankruptcy isn’t for everyone and isn’t always a good idea. Deciding to file bankruptcy is a serious decision and should be thought through carefully. If you are struggling with debt, it is useful to begin understanding bankruptcy early on, as it is a detailed process with many different considerations.
Liquidation vs. Reorganization
There are two basic types of bankruptcies filed by individuals: Chapter 7Part of the U.S. Bankruptcy Code allowing the liquidation of all of a debtor’s nonexempt assets to pay creditors; i.e., sale of property. (liquidation) and Chapter 13The part of the U.S. Bankruptcy Code allowing an individual to begin debt repayment without forfeiting property. Chapter 13 requires that the debtor maintain a source of income and adhere to a payment schedule set forth by the court. (reorganization). In a Chapter 7, you can eliminate your legal obligation to pay your debts but you may lose some of your property. In a Chapter 13, you enter into a payment plan to catch up on and pay down your debts over the course of three to five years.
It is important to note that within 180 days before filing bankruptcy, you must have received budget and credit counseling from a government approved credit counseling agency. Before your debts are discharged, you must complete an additional course on personal finances.
Chapter 7 ("Liquidation") Bankruptcy
A Chapter 7, or liquidation To sell all of a company’s assets, pay outstanding debts, and distribute the remainder to shareholders, then go out of business. , bankruptcy allows you to discharge certain debts, meaning to eliminate your legal obligation to pay them. However, where debts are secured — that is, where the loan is backed by collateralAn asset such as an automobile or a piece of property that a person uses when taking out a loan, promising to give the asset to the lender if loan payments cannot be met., such as a mortgage or a car loan — discharging the debt does not mean that you can keep the collateral. This means that you could lose your secured property in a Chapter 7 filing, unless you are able to continue making payments on the secured debt after you file for Bankruptcy. In addition, certain debts are not dischargeable at all, including most student loans, spousal or child support payments, criminal penalties, and many tax debts.
In order to qualify for Chapter 7, you must fall within a certain income level. You automatically pass the means testUnder the BAPCPA, a means test is a way to determine if a person can file for a Chapter 7 bankruptcy. Current monthly income is measured against the median income for a similar household in the same state. if your household income is below the median household income for your state. However, even if this is not the case, you may still be able to qualify based on your income and expenses.
When deciding if Bankruptcy is the right option for you at the time, it important to note that after debts are discharged through Chapter 7, a new Chapter 7 petition cannot be filed for eight years.
Bankruptcy laws called “exemptions” protect many different types of property. This means that, depending on what property you own, you may be able to keep some or all of it even after filing bankruptcy. Someone who is filing bankruptcy can choose whether to use property exemptions under federal law or property exemptions under state law. This means that if you are considering bankruptcy you should become familiar with your state’s specific bankruptcy laws in order to understand what property you would be able to keep. Some of the property that may be protected include pensions and retirement accounts, clothes and household items, certain amounts of equity in a home or car, and more. For the most part, future property is also protected. Property that is not exempt may be sold to pay your creditors before your debts are discharged.
Chapter 13 (“Reorganization”) Bankruptcy
In a Chapter 13, or reorganization, bankruptcy, you enter into a payment plan to catch up on and pay down your debts over the course of 3-5 years. Because of this, you must have regular income (enough to support the payments) to qualify. The payment plan you submit must be approved by the court.
The main advantage of a Chapter 13 bankruptcy over a Chapter 7 bankruptcy is that it allows you to keep property that might be lost under a Chapter 7 liquidation bankruptcy. For example, a Chapter 13 bankruptcy can give you a chance to catch up on payments of secured debts like a mortgage or car loan, allowing you to keep your house or car. In addition, Chapter 13 gives you the ability to protect valuable property that would not be exempt under Chapter 7. However, you will generally be required to pay the non-exempt value of this property to your creditors over the course of your payment plan.
Note that through Chapter 13, it is possible to reduce the overall amount owed on unsecured debt such as credit card debt. In addition, after the payment plan is complete, the creditor on a secured debt must treat you as if you never fell behind if you have caught up on your payments through the plan.
Bankruptcy and Credit Reports
The effect of bankruptcy on your credit reportInformation gathered from businesses and companies with which a person has a financial/business relationship (present or past). These could include department stores, banks, credit card issuers, and mortgage companies. Information on tax liens, bankruptcies, and lawsuits comes from court records. One free annual report can be ordered once every 12 months from each of the three major consumer-reporting agencies. is a common and important concern. A bankruptcy may appear on your credit report for up to ten years. If you have a good credit history, filing bankruptcy may make it harder to obtain future credit. However, if you are already behind on payments on several debts and already have significant negative information on your credit report, a bankruptcy may not actually make it harder to obtain credit once the delinquent debts have been discharged. Note that filing bankruptcy will most likely make it harder for you to obtain a mortgage to purchase a home.
Remember that while bankruptcy can have a negative impact on your credit report, you can continue to rebuild your credit over time after filing bankruptcy. While credit reports should be taken into account, whether bankruptcy is a good decision for you as an individual will depend on your circumstances.
Many debt situations can be avoided by keeping a budgetA budget is both a spending plan and a list of spendable funds. , saving for emergencies, and living within your income. Note that there are also situations that are unavoidable — loss of job, sickness, accidents, hospitalization, and destruction of property (e.g., through a flood, fire, earthquake, etc.). Bankruptcy is a legal process that allows individuals who are struggling with their debts to get a fresh financial start or to catch up on missed payments.
Deciding at what time to file bankruptcy is also an extremely important consideration. While a bankruptcy can eliminate or provide assistance with existing debts, it does not eliminate future ones. Remember, after debts are discharged under Chapter 7, you cannot file another Chapter 7 for eight years. If you are thinking about bankruptcy you should consider your overall financial picture in deciding not only whether to file, but also when is the right time to file so you do not end up back in the same situation a few years down the road.
Remember that filing bankruptcy is a serious decision that should be considered carefully. It is not a quick-fix to debt, and cannot take the place of good financial planning. However, for certain individuals who are struggling with debt, bankruptcy may provide the relief they need to get back on their feet.
If you are considering bankruptcy you should consult with an attorney in your state. Bankruptcy is a detailed process that can be very complicated. In addition, you should be careful of companies that promise they will get you out of debt without filing bankruptcy, or that offer to prepare bankruptcy papers for you without actually understanding your individual situation.