What is bankruptcy?
US bankruptcy laws provide a fresh start for overburdened debtors. Bankruptcy can help you pay off your debts through settlement, create viable debt repayment plans, or change the terms of your debt.
Bankruptcy is federal protection that helps people and businesses who cannot pay their debts. This can include debts such as personal loans, medical bills, and credit cards.
Most people who file for bankruptcy choose between liquidation (Chapter 7) bankruptcy and repayment (Chapter 13) bankruptcy. The type of bankruptcy you file determines whether you must sell your assets or make payments. It can also affect the amount of debt that is written off.
While some may cringe at the thought of filing for bankruptcy, it can provide much-needed financial relief and a fresh start for consumers.
That said, filing for bankruptcy is a tough decision that requires a lot of thought. Read on to find out what happens when you declare bankruptcy.
When should I declare bankruptcy?
If you're overwhelmed with debt but aren't sure whether bankruptcy makes sense, consider talking to a nonprofit credit counselor. This can be a good way to simultaneously pursue a bankruptcy and its alternatives. By law, you can't declare bankruptcy unless you meet with a nonprofit credit and budget counselor to review your spending habits.
Your advisor can guide you towards alternatives to bankruptcy. Or, after examining your case, the advisor may determine that bankruptcy makes perfect sense for you.
In some cases, people may have to consider bankruptcy after a life-changing event. Health crises or loss of income can make it difficult to recover without filing for bankruptcy.
There are other signs that you may need to consider bankruptcy. If you've taken out auto stock loans or payday loans, have less tax withheld from your paycheck, or plan to use your 401(k) to pay off debt, you may have enough debt to justify filing for bankruptcy.
If you think you might be a candidate for bankruptcy, it's a good idea to speak to an expert as soon as possible.
When should you avoid bankruptcy?
If you earn a lot to qualify
Bankruptcy will not always be the right choice. To discharge your debts through bankruptcy, which means that your debts will be forgiven, you must prove that you are unable to make payments to your creditors.
Therefore, high earners may not get the debt relief they expect through bankruptcy. Instead, they may need to file for bankruptcy, which allows them to restructure their debts, making it very easy for them to make payments but not cancel the debt entirely.
If you have recently declared bankruptcy
Bankruptcy will not work if you have recently received a bankruptcy discharge. Lawfully, you cannot receive a Chapter 7 discharge if you have received another Chapter 7 discharge within the past eight (8) years or a Chapter 13 discharge within the past six years. (Technically, you can file for more than six years if your total payments are 100% of your unsecured claims in your Chapter 13 bankruptcy.)
You also cannot receive a Chapter 13 discharge if you have received a Chapter 7 discharge within the past four years or a Chapter 13 discharge within the past two years.
If you have no risky assets
Even if you are legally qualified to declare bankruptcy, filing for bankruptcy can be a waste of resources. Some people are known as "judgment proof," so failure may not be a good option for them.
For instance, a person with minimal assets and no income other than Social Security income has no collectibles. Social Security earnings cannot be garnished to repay outstanding debts, leaving the person with no sizable assets. In this situation, filing for bankruptcy may not be wise because your debts are uncollectible.
Instead of filing for bankruptcy, one solution might be to open a bank account just for your Social Security earnings, which protects you from creditors. You can send a cease communication notice to stop collectors from calling.
If you can make payments by reducing expenses
A credit counselor can help you plan and lower interest rates on your existing debt. Credit counselors can track your spending for at least 30 days to identify discretionary income.
In addition, they teach customers how to compare prices and negotiate rates to reduce fixed costs. These simple plans can help some clients avoid bankruptcy.
Types of Bankruptcy
Chapter 7
This type of bankruptcy is the most common form of bankruptcy. According to the US Courts Administrative Office, in 2021, 70% of all non-commercial bankruptcy filings fell under Chapter 7.
Chapter 7, sometimes called liquidation bankruptcy, can force debtors to sell valuable assets to pay off part of their debt. However, this is not always the case.
Chapter 7 can be divided into two categories:
Asset Cases: In these types of filings, consumers have valuables that their trustee can sell to pay off some of their debt, including luxuries like boats, jewelry, and vacation homes. Nonetheless, your valuables can only be sold as long as they are not subject to federal bankruptcy exemptions or exceptions in your state. Be sure to check state and federal exemptions to find out where your assets are.
No Asset Case: In some Chapter 7 bankruptcy cases, the state or federal exemptions cover all of the debtor's assets, and they will not have to give up any of their assets. Depending on where you live, you may need to differentiate between federal and state exemptions.
It is possible for Chapter 7 bankruptcy to remain on your report for up to 10 (ten) years from the date of filing.
Chapter 13
This type of bankruptcy is the next most common form of bankruptcy. Known as a "wage earner's plan" by US courts, this form of bankruptcy forces debtors to follow a three- to five-year payment plan instead of liquidating their assets.
This plan can be viewed more appreciatively than Chapter 7 bankruptcy because the debtor pays at least part of their debt instead of paying it in full.
Chapter 13 can remain on your credit report for up to seven (7) years from the date of filing.
Chapter 11
Although generally reserved for businesses, debtors who do not qualify for Chapter 13 bankruptcy may qualify for Chapter 11.
Chapter 11 bankruptcy lets you reorganize your debt, although this plan may also require the sale of assets to pay off some of your debt.
How to declare bankruptcy?
1. Hire a lawyer
Filing for bankruptcy has long-term financial and legal implications. The United States federal court system advises consulting a bankruptcy attorney before filing.
Similar to researching forms of credit, you may want to meet with two or three bankruptcy lawyers before hiring one. It is common for bankruptcy lawyers to offer no-obligation meetings so clients can learn more about their fees and procedures.
The bankruptcy process can be costly. Between filing fees and attorney fees, the average case cost of Chapter 7 bankruptcy is about $1,788, while Chapter 13 bankruptcy costs about $3,313 in direct costs.
If you cannot pay your taxes, you can get legal aid.
2. Gather your financial documents
When you file for bankruptcy, you will need to disclose your income, assets, and debts. This will give your lawyer, your trustee, and the courts an idea of your financial situation and may help you determine the type of bankruptcy you should file.
3. Get debt advice
The Federal Bankruptcy Code requires that you obtain pre-bankruptcy debt counseling from a licensed provider at least 180 days prior to your filing. After declaring bankruptcy, you may also need to complete a debtors training course before you can pay off your debts.
4. Filing your bankruptcy petition
Your lawyer will then file a formal request. For this part, you will need to provide the following documentation:
Any payment slip received 60 days before the deposit
Certificate of credit counseling
Copy of the debt payment plan created during the credit counseling
Schedule of assets and liabilities
Schedule of contracts and unexpired leases
Schedule of current income and expenses
Statement of financial affairs
5. Meeting of creditors
The meeting of creditors, or 341 hearing, is when you meet with the trustee and the creditors. You will be questioned about your application and asked to verify the information provided during this time.
The average Chapter 7 case takes four to six months before your debts are discharged. With a Chapter 13 case, the debts will not be discharged until you complete the three to a five-year payment plan.
Alternatives to Bankruptcy
If bankruptcy doesn't make sense to you, there are other options to reduce your debt:
Debt consolidation: This is a common alternative to bankruptcy. Consider a debt consolidation loan if you want to reduce your interest rates or monthly payments. This type of loan lets the borrower accumulate several debts in a single loan with a fixed interest rate and a monthly payment. Ideally, you should find a loan with a lower interest rate.
Debt management: In a debt management plan, a not-for-profit credit counseling organization negotiates interest rate changes on your behalf. These companies typically specialize in lowering credit card interest rates and often charge a small fee for their services.
Debt Settlement: If you have cash on hand, a debt collector may accept a lump sum payment to settle your debt. They may only accept 25 cents per dollar you owe, but you must pay on the spot. Debt settlement companies and lawyers may offer to negotiate on your behalf. This option makes more sense if you have cash on hand.
Forbearance: Some creditors may offer you a forbearance if you are having trouble meeting your debts. In this case, you can suspend payments for a certain period of time. Interest can continue to accrue on your debt while you miss payments, so make sure you understand the terms of your contract and make a plan to get back on track.
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