The Basics of How Personal Bankruptcy Works
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When successfully managed, debt can be a useful tool. But when you can no longer effectively leverage your income against your liabilities, it could mean your debt is out of control. Personal bankruptcy offers one way to help clear out unmanageable debt.
The two most common personal bankruptcy types are Chapter 7 and Chapter 13. Here’s the difference between the two as well as the ins and outs of bankruptcy.
- Comparing Chapter 7 vs. Chapter 13 bankruptcy
- Should you file for Chapter 7 or Chapter 13?
- The downsides of personal bankruptcy
- The process of filing for bankruptcy
- Alternatives to declaring personal bankruptcy
Comparing Chapter 7 vs. Chapter 13 bankruptcy
Chapter 7 personal bankruptcy
Chapter 7 is a liquidation bankruptcy. When a consumer qualifies to file Chapter 7, they will liquidate whatever unprotected assets are required and use the funds to make payment to creditors. These nonexempt assets might include a second car, collectibles and recreational vehicles. Assets exempt from liquidation include retirement savings, household furnishings and assets you require to maintain a job or a home.
Any remaining debt after liquidation is discharged so you can start clean, albeit with a bankruptcy on your credit report for 10 years. Chapter 7 is popular in part because it requires no ongoing payment plan by the debtor.
Filing for Chapter 7 stops all collection activities against you and prevents creditors from filing lawsuits against you. It may even stop an eviction. But it’s not enough to want to file personal bankruptcy Chapter 7; you also have to qualify. That entails completing a means test to measure your income, assets, and liabilities to prove that you can’t afford to pay off your debts.
Chapter 13 personal bankruptcy
Chapter 13 bankruptcy is an option for those who don’t qualify for Chapter 7 or those who have specific assets they want to protect from liquidation. When filing Chapter 13 bankruptcy, the goal is to create a payment plan that gets you out of debt in three to five years. Any eligible debt that remains after executing the payment plan is discharged; debt that is ineligible for discharge includes mortgages and alimony or child support debt.
Chapter 13 is especially appealing to those with a home heading for foreclosure because it can stop a foreclosure and give them time to rectify their mortgage delinquency. Record of the bankruptcy will remain on a credit report for 7 years after completion of the payment plan.
Should you file for Chapter 7 or Chapter 13?
When your nonexempt debts have reached a point that you see no way of paying them off and it’s becoming difficult to meet all your other financial obligations, it might be time to consider filing bankruptcy.
You can use these questions to help you determine whether Chapter 7 or Chapter 13 would make more sense for your financial situation:
- Do you have assets you want to protect? Chapter 7 requires liquidation of assets not used to maintain a home and job. Chapter 13, on the other hand, protects assets by avoiding liquidation in favor of an ongoing payment plan.
- Are you unable to afford repayment? Chapter 7 helps those who are unable to make any meaningful payments to help clear their debt.
- Do you want to buy a home soon? The waiting period for mortgage approval may be shorter when you file personal bankruptcy Chapter 13. In some cases, you may even be able to qualify for a mortgage post-Chapter 13 discharge after just 1 year.
- Do you need to catch up on mortgage payments? Chapter 13 is designed to help stop foreclosure and give time to catch up on mortgage delinquencies.
- Have you filed bankruptcy in the past? You must wait 8 years after filing Chapter 7 before filing a second Chapter 7 but only 4 years to file Chapter 13. You must wait 2 years before filing a second Chapter 13, but if you want to file Chapter 7 after filing Chapter 13, you can generally do so after 6 years.
The downsides of personal bankruptcy
Bankruptcy offers debt relief and a fresh start to many, but there are some downsides, including:
- The cost. With filing fees, trustee fees, and attorney fees, filing for bankruptcy isn’t free. The amount saved in discharged debts needs to exceed the cost of the bankruptcy for it to be worth filing.
- It negatively impacts credit. A bankruptcy will stay on your credit report for up to 10 years, which can affect your ability to secure credit. It’s important to consider, however, that the impact of a bankruptcy on a credit score might not be as bad as delinquent debts and collection accounts.
- It becomes a public record. A bankruptcy filing is a public record, so your employer and anyone else who searches for it can find out about it. In some cases, the information may even be printed online or in a local newspaper.
- Not all debts are dischargeable. If much of your debt comes from student loans, alimony, child support, back taxes, or any other form of ineligible debts, then bankruptcy won’t help.
- Filers may lose nonexempt property. Declaring bankruptcy can mean a loss of certain unprotected property, such as recreational vehicles.
The process of filing for bankruptcy
The first thing you want to do is consult with a bankruptcy attorney. While you can file for bankruptcy without an attorney, their help can be invaluable in identifying exempt and nonexempt debts and assets, completing the paperwork, creating a repayment plan or taking the means test, and representing you during the court meeting with your creditors.
Next, no matter what type you want to file, you’ll be expected to have credit counseling. After that, the initial filing paperwork is completed and turned in, followed by the means test for Chapter 7 and the payment plan for Chapter 13. At this time you should also find out if your local courts have any special forms or requirements.
After filing, a trustee will arrange for a meeting with your creditors. During this meeting, your creditors can ask questions about your plan and your income.
Alternatives to declaring personal bankruptcy
Bankruptcy isn’t the first solution to resolving debts you’re having trouble paying. Instead, it’s an option worth exploring once you’ve exhausted every other alternative, such as:
- Making payment arrangements. Some creditors will work with you to create payment plans that can prevent bankruptcy. In some cases, these might even include balance reduction or removal of late fees and interest.
- A debt consolidation loan. After taking out a loan to consolidate debt, you can try to negotiate lower payoff balances with creditors. A loan also makes debt management easier by reducing you to a single payment and due date.
- Credit counseling. Being overwhelmed by your debt could be the result of financial inexperience. With counseling, you may learn effective habits that help you easily manage your debt without bankruptcy.
Bankruptcy offers a variety of workable solutions for freeing yourself from debt. It might not be the first option explored when you feel the weight of debt, but it’s there when you determine that your debt is too overwhelming to pay off on your own.