Personal Bankruptcy: What You Should Know
Bankruptcy is a confusing business. There are several different codes to choose from, numerous laws to traverse, and all kinds of pitfalls to avoid. But if you’re battling with escalating debts and nuisance creditors, it could be your only avenue of escape. With that in mind, this guide will cover everything you need to know about personal bankruptcy protection and the many nuances of bankruptcy codes.
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Types of Bankruptcy
The two most common types of bankruptcy in the United States are Chapter 7 and Chapter 13, but they’re not the only ones. If you’ve ever wondered why rich celebrities and successful business owners can file for bankruptcy and retain their assets while you’re threatened with complete financial ruin, it may come down to the specific bankruptcy code you file for.
There are two types of personal bankruptcy: Chapter 7 and Chapter 13. According to the US Courts, filings are split roughly 70/30 in favor of Chapter 7, but the right option for you will depend on numerous factors, including your assets, debts, and whether you’re suffering any financial hardship.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy works by liquidating your assets and using the funds to repay creditors. It’s quick, it’s simple, and it’s also cheaper to file than Chapter 13, but it’s not without its issues.
You will be means-tested to ensure you qualify for a Chapter 7 filing and you will also need to have a minimum amount of debt to qualify. It’s possible to be rejected for bankruptcy because you don’t have enough debt or because you’re not experiencing enough hardship.
The requirements change from state to state, but generally, you can keep your house, car, and any important equipment that you need for work. However, you will also lose all of your credit cards and non-exempt assets and your credit score will suffer, with a derogatory mark remaining for 10 years.
Unpaid medical bills are the most common reason to file for Chapter 7 bankruptcy and lead tens of thousands of individuals down this path every single year. It can help with these debts and can ensure that unsecured creditors are placated, but it won’t clear all types of debt and may not be the best option for secured debt.
Pros of Chapter 7:
- Lenders will stop harassing you.
- It is much simpler than Chapter 13 and can cost up to $2,000 less when filing fees and attorney fees are accounted for.
- There are a number of exempt assets you can retain.
- Most of your debts are cleared.
Cons of Chapter 7:
- You will lose property that has not been exempt by the bankruptcy trustee.
- Your credit score will drop by up to 200 points and a derogatory mark will remain on your report for 10 years.
- Student loans and child support obligations will remain.
- If you don’t have a mortgage, you may struggle to acquire one before the bankruptcy disappears from your credit report.
- You will lose all of your credit cards.
Requirements for Chapter 7:
As discussed above the requirements for filing Chapter 7 bankruptcy differ from state to state, but generally, you will need:
- A debt-to-income ratio greater than 50%.
- Debt that is so severe it impacts your family life and mental health.
- A total debt repayment period of at least 5-years.
- Little to no disposable income.
- An income that is below average.
- You will be asked to attend a credit counseling session before filing for bankruptcy.
Chapter 13 Bankruptcy
If Chapter 7 is all about liquidation, then Chapter 13 is all about restructuring. It’s less destructive, but it can also be more expensive and selective, and may not be available to you.
The goal of Chapter 13 bankruptcy is to create a detailed repayment plan, one that ensures your creditors get what’s owed to them while you keep your assets. You need to explain your situation to a bankruptcy court, telling them how you got into this mess and proving you have the means to get out of it.
The bankruptcy court will look at your disposable income (the money left after you’re covered necessities such as food and utility bills) to determine if you can repay your debts. Most of this income will go towards those debts, leaving you with very little cash leftover.
Pros of Chapter 13 Bankruptcy:
- You can keep most of your property, including assets such as a home and car.
- You can file for bankruptcy more often with Chapter 13.
- The Chapter 13 bankruptcy process is more forgiving than Chapter 7.
- You will be given flexible repayment terms by your bankruptcy trustee.
Cons of Chapter 13:
- Alimony/Child support payments will not be discharged.
- Student loans will remain when you file for bankruptcy.
- You will need to repay most of your unsecured debts via the structured repayment plan.
- It can take several years to repay your debts under Chapter 13 bankruptcy.
- It will remain on your credit report for 7 years.
- You will lose all of your credit cards.
- It will be close to impossible to acquire a mortgage for many years.
Requirements of Chapter 13 Bankruptcy
There are very specific requirements here and these need to be met if you’re going to successfully file for bankruptcy:
- Your secured debt cannot exceed $1,257,850 (based on recent figures, subject to change).
- Your unsecured debt cannot exceed $419,275 (based on recent figures, subject to change).
- You need to be active with tax filings and show proof of at least 4 years of reports.
- You need to prove that you can afford to repay your debts.
- You will be asked to attend a credit counseling session before filing for bankruptcy.
What are the Other Forms of Bankruptcy?
There are three other forms of bankruptcy in the United States. As an individual, you cannot file for any of these and can skip this section. If you run a business, however, they may be relevant:
In the past, if a municipality was in debt then the creditor could force them to raise taxes to cover that debt. These days they can file for Chapter 9 bankruptcy, which helps them to restructure their finances without raising taxes and asking their citizens to shoulder the burden. In most cases, the city needs to have permission from the state before they can file.
Businesses can use Chapter 7 bankruptcy to repay their debts, undergoing the same process used by individuals. They can also choose Chapter 11, which may be more preferable.
Chapter 11 helps businesses to restructure their finances, allowing them to continue operating as normal, albeit with a few exceptions. The trustee can take over and it’s possible to acquire an automatic stay that prevents anyone from continuing with lawsuits filed against you.
Chapter 12 bankruptcy is aimed at farmers, who have unique needs and may struggle to find a solution with other forms of bankruptcy. In many ways, it’s similar to Chapter 13, but claimants can file even if their debts are higher than the usual limits.
Chapter 15 is by far the least common of US bankruptcy codes. It is used by foreign debtors to gain access to the US bankruptcy courts and proceedings when filing in another country.
How do You Know Which Type to File for?
Assuming you don’t run a business or a city, then the only question is whether you should file for Chapter 7 or Chapter 13. The former is by far the most common and will suit the needs of most Americans, but the latter is more preferable in many situations. You can seek help from a credit counselor or bankruptcy attorney if you’re not sure, but here is a little comparison to help you:
Takes just a few months from start to finish, after which you can focus on rebuilding your credit.
It may take up to 5 years for you to repay your creditors.
You can keep your main home and car and lose only nonexempt property and assets.
None of your assets will be liquidated when you file for bankruptcy protection.
You may not qualify if you have a high income.
You need to have a regular income so you can meet the repayment schedule.
Your income must be below the average for your state and you need to prove you can’t repay debts quickly or easily.
No income eligibility, but your debts need to be below a specific amount.
The average costs are between $1,000 and $2,000.
The average costs are between $3,000 and $4,000.
To the average layperson, bankruptcy laws are complicated and confusing, but that’s why attorneys exist. Don’t assume you can successfully file on your own, especially if you have little legal knowledge and no experience. A top-rate bankruptcy attorney can significantly increase your chances of a successful filing and help you to retain more of your assets.
Contact a bankruptcy attorney or law firm, discuss your situation with them, and let them file the bankruptcy petition for you. The hassle and assets it can save you is well worth the additional costs of hiring a legal professional.
Consequences of Filing for Bankruptcy
Bankruptcy should never be seen as an easy way out. It’s true that it can greatly reduce your obligations and either eradicate your debts or make them more manageable, but there are some severe consequences and it could take years to rebuild.
How Does Filing for Bankruptcy Affect your Credit Score?
Your credit score can drop by as many as 200 points when you file for bankruptcy and if your credit score is in the Exceptional range (unlikely for anyone preparing a bankruptcy filing) you can suffer even more.
Bankruptcy will remain on your credit report for between 7 and 10 years, but the damage it does will lessen over time and stop having a major effect on your credit score after 4 or 5 years. This is why it’s hard to acquire new credit after finalizing a bankruptcy case and why you may need to wait up to 7 years before you’re accepted for a favorable rate mortgage.
How to Rebuild Credit After Bankruptcy
The idea that bankruptcy will ruin your credit forever is a myth. It may take years to recover, but recover you can. There are a few things you can do to improve your credit score while waiting for the effects of bankruptcy to diminish.
- Check Your Report Regularly: Make a habit of checking your credit report at least every few months. If anything appears that shouldn’t be there, dispute it. Fraud is common, as are mistakes, and both can damage your credit score further and prevent you from rebuilding. One of the most common mistakes after bankruptcy is to show discharged debts as active.
- Meet Other Obligations: Your student loans and tax debts will not be included in your bankruptcy filing and will remain active during and after. It’s important to keep paying these debts to avoid further damage and to steadily rebuild.
- Avoid Scams: Some credit repair companies will promise to remove the effects of bankruptcy from your credit report or help you to rebuild, all for a single, lump-sum payment. But, as you might have gathered, it’s all a con. There’s nothing they can do except walk away with your money.
- Get a Secured Credit Card: Unsecured credit cards may be out of the question, but you shouldn’t have an issue acquiring a secured one. It can be used in the same way and improve your report just as quickly, but because it’s secured against a cash deposit, there’s little risk of acquiring large debts you can’t repay.
- Get a Co-signer or Become an Authorized User: If you know anyone with good credit who can help you out, ask them to co-sign on a loan or credit card. They can also add you as an authorized user, boosting your credit utilization ratio without increasing your debt.
- Keep New Applications to a Minimum: You need credit to build credit, there’s no doubt about that, but every new application and every new account will reduce your score. Only apply when you absolutely need to and don’t acquire too many credit accounts.
How to File for Bankruptcy
If you have taken all the above into consideration and are still confident that bankruptcy is the right option for you, there’s just one thing left to do: File.
The filing process is different whether you’re filing for Chapter 7 or Chapter 13, but there are some key similarities, and, in both cases, you’ll need a little money, a lot of time, and a whole heap of paperwork. We recommend working with a bankruptcy attorney for any bankruptcy case, but if you want to go it alone, you can take a look at the following steps.
What are the Steps for Chapter 7?
The first step for filing for Chapter 7 bankruptcy is to analyze your debts—gathering information of all balances owed from all types of debt. A few things need to be considered here:
- You cannot claim child support or alimony.
- You cannot claim student loans or tax debt.
- If you have pledged any assets against a debt, the lender may simply take those assets.
If most of your debt obligations consist of these non-dischargeable debts, Chapter 7 may not be the right option for you.
Once you have completed this step, you need to make sure you’re eligible and check to see what assets are exempt. Exemption law and means-tested eligibility differs from state to state, so you’ll need to check with your local laws. Generally speaking, however, you’ll need an income that is below the median state average.
It’s important to understand what is exempt before you file, lest you lose any assets you can’t afford to lose.
Once you have all the paperwork, you need to complete a credit counseling course. This can be taken online or over the phone and should cost less than $50. A credit counselor will assess your situation, provide some basic advice, and then make recommendations regarding budgeting, debt relief, and bankruptcy.
After this, you can file a petition and start your case. You will be asked to pay a filing fee when you file these forms, but if you can’t pay this all at once you can request that it be split into four separate payments. Once these forms have been filed, you will be tasked with submitting financial and personal documents to a trustee and then meeting with the bankruptcy court.
Objections can be filed, debts will be wound-up, and the case will be finalized. This typically takes 3 to 4 months, after which you’ll be freed from all your unsecured debts and can start looking towards a brighter, debt-free future.
What are the Steps for Chapter 13?
If you have determined that Chapter 13 is the right option for you, you need to analyze your debts and compare these against the most recent unsecured/secured debt restrictions. Unless you’re drowning in 6-figure and 7-figure sums, there’s little chance you will exceed these limits.
As with Chapter 7, it’s important to calculate the debts that will benefit from a filing and the ones that will not. For instance, while most debts will be negotiated down, you will need to repay mortgage debts and tax debts in full during the assigned repayment period. If most of your debts are tied-up in mortgages and taxes, then there may be little to gain from filing for bankruptcy.
Your income also needs to be factored into the equation—if it’s too low, you can’t propose a repayment plan and may be dismissed.
Once you have this information you need to complete the relevant bankruptcy forms, acquire a credit counseling certificate, and pay your filing fee. The trustee will then request personal and financial documents (paychecks, bank statements) and you will be asked to attend two hearings, first with the trustee/creditors and then with the judge.
After this, you will be required to start making payments on your debt, take a debtor education course, and then finalize the process. Your debts will be repaid over the following 3 to 5 years.
Who Can Help?
A bankruptcy attorney can help you eliminate the hassle, stress, and the frustrations associated with filing on your own. They will charge you between $1,000 and $3,000 depending on the type of bankruptcy you file, the state you live in, and the experience of the attorney, but they’re usually worth their weight in gold.
Many attorneys will also charge you for additional time spent in court, as is the case when there is a dispute or other issue, but such complications are rare.
There are attorneys that will take your case pro bono, which means you’re not required to pay any fees. However, legal aid is hard to come by as it’s seriously underfunded and constantly in-demand.
Summary: Bankruptcy with the Right Help
Filing for bankruptcy will cost you less than $500 when accounting for filing fees, credit counseling courses, and a trustee. This is an easily affordable amount, especially if you skip your monthly payments for a month or two. Once you add attorney fees on top, that affordable figure can inflate to an unaffordable sum and it’s no surprise that many debtors try to skip the legal experts and go it alone.
However, you are twice as likely to succeed with an attorney and their experience is invaluable. All the online bankruptcy guides in the world can’t compete with knowledge acquired from decades of bankruptcy cases.
Use the National Association of Consumer Bankruptcy Attorneys website to find an attorney that can represent you in your area and make sure you get the best help when undertaking this immense, life-changing process.