Long ago, if a person couldn’t pay their debts, they went to prison. This punitive approach ruined their lives, plus made it unlikely that the creditors would ever get their money. Today, we have the option of declaring bankruptcy.
Bankruptcy is a process by which you can be forgiven from debts you can no longer pay, while settling with creditors for part of what you owe.
Types of Bankruptcy
Federal law allows for several different types of bankruptcy, but today we’ll focus on two: Chapter 7 and Chapter 13.
Chapter 7 Bankruptcy
Most people thinking about bankruptcy think of Chapter 7. In this type, you sell off many of your assets and use the proceeds to settle your debts. The court decides how much goes to each creditor, and the remainder is discharged. You give up most of your assets, but in return you get a fresh start.
Not everyone can file Chapter 7 bankruptcy. You have to either make less than the median income for your state or have a very low disposable income after you pay for essentials.
Some property is exempt from being sold in your bankruptcy. This varies from state to state, but exemptions may include some equity in your home, equipment you use for work, Social Security checks, veterans’ benefits, and retirement savings. You will, however, need to sell a second home, any valuable collections, or stocks.
Likewise, some debt will not be erased by bankruptcy. This may include student debt, unpaid taxes, child support, and fines owed to the government. Bankruptcy erases unsecured debt, like credit cards or medical bills. But when it discharges secured debt, like a mortgage or auto loan, it doesn’t prevent the creditor from repossessing the property.
Chapter 7 bankruptcy remains on your credit report for ten years.
Chapter 13 Bankruptcy
Unlike Chapter 7, Chapter 13 doesn’t wipe away debts right away. Instead, you agree to a payment plan for 3-5 years. Only if you stay current on these payments will the rest of the debt be erased at the end.
Chapter 13 bankruptcy doesn’t have the income limits of Chapter 7. However, you can’t have more debt than a certain limit, which changes frequently.
It comes with an inherent risk: most Chapter 13 filers will not successfully complete their payment plan. Then the creditors can go after you again, unless you then try to file Chapter 7 bankruptcy.
On the bright side, Chapter 13 bankruptcy allows you to keep your assets. If you have important assets you don’t want to lose, and you believe you can stay current on payments for years, it might work for you.
Chapter 13 bankruptcy stays on your credit record for seven years.
Should You File for Bankruptcy?
No one wants to go bankrupt. It comes with negative consequences like these:
- A black mark on your credit report that lasts for years, restricting your access to credit when you need it
- Loss of property
- Any co-signers on your loans may have to pay the entire loan
- Social stigma: judgment from friends, family, and potential employers
That said, sometimes those consequences don’t look that bad, compared to your current situation. Falling behind on payments also destroys your credit. By the time you contemplate bankruptcy, your credit may already be terrible. Besides, bad credit means you won’t be tempted to borrow more money and get back in the same situation again. And losing property may happen anyway when creditors come after you.
Before considering bankruptcy, you should exhaust other available options. Selling assets you can live without can give you money to pay off loans. Many creditors will set up a payment plan if it means you will eventually pay in full. Contact a credit counselor for advice on managing your debt or negotiating some debts down.
If you’ve tried all this without success, it may be time to file for bankruptcy. Experts suggest filing if your bills regularly exceed your income, or if you see no way to get out of debt within five years.
Declaring bankruptcy takes about four months and costs a few thousand dollars. Just because you file doesn’t mean your case will be approved, but most bankruptcy filings are.
First, you need to gather all your financial records together. Make sure you’ve listed every debt and asset, and have documentation for each.
Next, get bankruptcy counseling. Federal law requires you to attend this no more than 180 days before filing. You will receive a certificate of completion.
You may wish to hire a bankruptcy attorney. While one isn’t required, no one else at court will advise you. The legal issues are complex, so professional guidance can make a difference in how much you are allowed to keep.
At last, you file a bankruptcy petition. At this point, creditors have to pause their collections activities. A bankruptcy trustee manages your case. You usually do not have to appear in court, only at a meeting of your creditors.
The court will decide how much of your debt will be discharged and which of your assets will be liquidated. If you filed Chapter 13 bankruptcy, you will need to agree to your payment plan and begin making payments.
You must complete a debtor education course. This should help you avoid similar problems with debt in the future.
Finally, your eligible debts are discharged and your bankruptcy process is over.
Get Advice Before Filing
Before you consider filing for bankruptcy, speak to a financial advisor about less drastic options. If you can handle your debt some other way, you can avoid the costs and consequences of a bankruptcy case. But in some cases, bankruptcy can offer a fresh start and a chance to rebuild your credit afterward. Contact us to connect to a financial advisor who can offer solid advice about your debts.